1. Essential Knowledge for Investment and Financial Planning
Let’s explore the basic and essential knowledge that you must know when engaging in investment and financial planning.
In South Korea, unlike other developed countries, schools do not teach the essential investment knowledge necessary for life. Even in high school and university, there are few places that teach the practical investment knowledge needed for daily life beyond theoretical investment concepts.
Modern society is becoming increasingly complex, moving from the smartphone era to the AI era. In this rapidly changing world, nothing is guaranteed as it was before.
Even being a civil servant no longer guarantees a stable life. As society evolves, the pension system and job stability for civil servants are likely to change in the near future.
The title of a doctor may no longer guarantee a high income for life. The number of medical school seats is increasing, and with the advent of the AI era, technological innovations may significantly threaten the job security of doctors.
The myth of real estate being an unbeatable investment in South Korea may also crumble. With the problem of population decline and changing concepts of housing, the country is entering an era of long-term low growth, similar to Japan.
In this post, I will outline the essential knowledge that you must know for successful investment and financial planning.
2. Understanding Risk (RISK)
In South Korea, the term “risk” in investment and financial planning is often perceived negatively. However, in investment, risk should be understood as “the volatility of investment value” or “the uncertainty of potential profit and principal loss.”
Simply translating “risk” to the Korean word “위험” (danger) can instill a negative perception of investment and financial planning, leading to missed opportunities for asset growth through various investment products.
Understanding risk as the volatility and uncertainty in investment is a key element of successful investing.
3. Two Principles to Reduce Risk
Long-Term Investment
Long-term investment has the effect of reducing market risk. Markets fluctuate daily, monthly, and yearly, showing unpredictable results at each point, much like the varying slopes of a curve. However, over 5, 10, or 20 years, large companies and industries are more likely to show upward trends, thereby reducing market risk and increasing the chances of successful investment and financial planning.
Diversification
By diversifying investments across various sectors and companies, rather than putting all your money into one company or sector, you can hedge market risk. Just as fund managers design funds, individual investors should establish their own principles and create a personal investment portfolio. By determining the ratio of savings products to investment products and diversifying within those categories, investors can reduce market risk and achieve stable long-term returns.
4. Major Types of Risk
Market Risk: The risk arising from fluctuations in the overall market, affecting all investment assets, including stocks, bonds, and commodities. Examples include stock market declines, interest rate changes, and exchange rate fluctuations.
Credit Risk: The risk that an issuer of bonds or loans may default on principal and interest payments, particularly significant in bond investments. A downgrade in a company or country’s credit rating falls under this category.
Liquidity Risk: The risk that an asset cannot be easily converted to cash when needed. Real estate or unlisted stocks are examples of assets with high liquidity risk.
Operational Risk: The risk arising from the operation of a company, including human error, system failures, and legal issues.
Legal/Regulatory Risk: The risk arising from changes in laws or regulations, such as new laws, regulatory tightening, or tax policy changes, which can affect investments.
Political Risk: The impact of political instability, government policy changes, and international conflicts on investments, crucial when investing in specific countries or regions.
Interest Rate Risk: The risk that changes in interest rates will affect bond prices or borrowing costs, with rising interest rates typically leading to lower bond prices.
Exchange Rate Risk: The risk that fluctuations in exchange rates will affect the value of overseas investment assets, important to consider when investing in foreign stocks, bonds, or real estate.
5. Risk Management Strategies
Diversification: Spread investments across multiple assets to minimize the impact of losses in any single asset on the overall portfolio.
Hedging: Use derivatives and other financial instruments to offset risk. For example, futures contracts can be used to hedge against price fluctuations.
Research and Analysis: Conduct thorough research and analysis of the financial condition of investment targets and market conditions to identify risks in advance.
Portfolio Rebalancing: Regularly review and adjust the portfolio to manage risk by changing investment ratios.
Setting Risk Tolerance Levels: Clearly define your investment goals and risk tolerance to ensure that your investments align with your financial objectives.
6. Categories of Investment Products: Savings and Investment Products
Investment products can be broadly categorized into savings investments and investment products. In simple terms, savings investments are products with no risk of principal loss but lower expected returns. On the other hand, investment products carry the possibility of principal loss but offer higher expected returns. By understanding the differences between these two categories and adjusting the ratio according to the investor’s age and life cycle, stable long-term returns can be achieved.
A. Savings Investments
Savings investments focus on stability, aiming to grow assets by earning interest while protecting the principal. Typical examples are savings products offered by banks.
Money needed for immediate living expenses should be placed in savings investment products. After covering living expenses and saving for a stable fixed income until retirement, you can invest in investment products with the remaining funds to enhance your overall expected return.
Types:
- Fixed Deposits: A savings product where funds are deposited for a fixed period, earning interest upon maturity. It offers stable returns with a fixed interest rate.
- Installment Savings: A savings product where a fixed amount is deposited monthly, with the principal and interest paid at maturity. It’s suitable for setting and achieving financial goals.
- Housing Subscription Savings: A savings product for housing subscriptions, allowing the accumulation of points for housing lottery qualifications.
Advantages:
- Stability: The principal is guaranteed, so there is a low risk of loss.
- Predictability: Earnings can be predicted with fixed interest rates.
- Convenience: Easy to manage with minimal attention needed during the deposit period.
Disadvantages:
- Low Returns: Returns are lower compared to investments in stocks or real estate.
- Liquidity Constraints: Early withdrawal from fixed deposits may be difficult.
B. Investment Products
Investment products involve investing in tangible assets such as commodities, energy, and metals. They differ from stocks and bonds and can serve as a hedge against inflation.
Types:
- Gold: Known as a safe-haven asset, popular during economic uncertainty.
- Silver: Similar to gold but more volatile, with prices influenced by industrial demand.
- Oil: An energy resource sensitive to global economic and political conditions.
- Agricultural Commodities: Investing in products like coffee, sugar, and wheat, with prices affected by climate and supply-demand dynamics.
Advantages:
- Diversification: Diversifying the portfolio with different asset classes from stocks or bonds.
- Inflation Hedge: Commodity prices often rise with inflation, providing a hedge.
- Profitability: Potential for high returns during specific periods.
Disadvantages:
- Storage and Transaction Costs: Physical assets may incur storage costs and transaction fees.
- Volatility: Prices can be highly volatile due to economic, political, and natural factors.
- Specialized Knowledge Required: Understanding and analyzing each commodity is necessary.
7. Investment and Financial Planning Strategies by Age and Life Stage
Investment and financial planning require a long-term approach. Investing all your wealth in high-risk products for quick profits or using essential living funds for financial planning can lead to financial ruin, not only for yourself but also for your family.
It’s essential to establish a long-term plan based on the investment strategies for different life stages outlined below.
Adjusting your investment approach according to your age and life stage is a crucial financial management strategy. Each stage has different financial goals and risk tolerance levels, requiring an appropriate investment approach. Below are common investment strategies for different age groups.
1. 20s – Early Career Stage
Goals:
- Begin asset accumulation
- Utilize long investment horizon
- High risk tolerance
Investment Strategy:
- Stocks: Invest in high-growth potential stocks for long-term asset growth.
- ETFs: Use Exchange Traded Funds (ETFs) to diversify across various assets.
- Savings: Save a portion in high-yield savings accounts for emergencies.
- Invest in Knowledge and Skills: Invest in education and certifications for self-development.
2. 30s – Career Development and Family Formation Stage
Goals:
- Continue asset growth
- Prepare for major life events like marriage, home purchase, and child-rearing
- Set medium- and long-term goals
Investment Strategy:
- Stocks and ETFs: Maintain a growth-focused investment approach but diversify some into safer assets.
- Bonds: Include bonds in the portfolio to reduce risk.
- Retirement Funds: Contribute actively to retirement accounts like 401(k) and IRA.
- Real Estate: Consider home ownership as a means of asset growth.
3. 40s – Stability and Mid-Life Stage
Goals:
- Continue asset growth
- Prepare for children’s education expenses
- Begin serious retirement planning
Investment Strategy:
- Stocks: Maintain investments in stocks with both growth and stability.
- Bonds and ETFs: Increase bond allocations to strengthen portfolio stability.
- Real Estate: Consider investment properties and rental income.
- Education Savings: Utilize education savings plans like 529 plans for children’s education expenses.
4. 50s – Enhanced Retirement Preparation Stage
Goals:
- Protect assets and seek stable income
- Intensify retirement preparation
- Pay off debts
Investment Strategy:
- Safe Assets: Increase holdings in bonds and high-dividend stocks for stable returns.
- Retirement Funds: Maximize contributions to retirement accounts and reassess investments.
- Real Estate: Pay off debts to increase net assets and secure cash flow.
- Insurance: Consider long-term care insurance and life insurance to mitigate risks.
5. 60s and Beyond – Retirement and Later Life Stage
Goals:
- Secure stable income
- Manage assets and spending
- Prepare for healthcare and retirement living expenses
Investment Strategy:
- Fixed-Income Assets: Focus on bonds, annuities, and high-dividend stocks for steady cash flow.
- Cash and Short-Term Savings: Maintain a significant cash reserve for living expenses and emergencies.
- Real Estate: Maintain primary residence and consider additional income from rental properties.
- Healthcare Preparation: Utilize health insurance, Medicare, and long-term care insurance.
8. Principles to Follow in Investment and Financial Planning
Do Not Invest in Products You Do Not Understand!
Many people purchase savings and investment products designed by various financial institutions. However, when asked about basic information on these products, most investors have little understanding of the details. Investing in products you do not fully understand, relying solely on others’ advice, is a recipe for failure.
Take sufficient time to study investment products, understand your financial situation, and then decide whether to invest.
Invest in Products Managed by Reliable Asset Management Firms and Financial Institutions!
South Korea has approximately 300 asset management firms, offering various investment products to customers. Most of these products involve the risk of principal loss but offer higher expected returns. However, among the 300 asset management firms, only a few consistently deliver high returns.
If you lack information on asset management firms, it is advisable to invest in products managed by top-tier and well-established firms. Alternatively, consider investing in funds or variable insurance products managed by first-tier financial institutions.
Check the Fine Print When Signing Up for Investment Products!
Many people focus solely on the product’s expected returns and overlook the fine print when signing up for investment products. Developing a habit of thoroughly checking the fine print is crucial. Some investment products have clauses like “profit distribution after three years,” which may not be favorable to you. If you find the fine print disadvantageous, it may be wise to reconsider the investment.
Check Fees When Investing in Stocks and Funds!
Asset management firms that manage funds take a portion of the investment profits as fees. The actual profit after deducting fees and taxes from the investment returns is what you take home. Some investment products may seem attractive on the surface but have high fees. Always check the associated fees before signing up for an investment product.
Actively Utilize Tax-Exempt Investment Products!
Both savings and investment products are subject to taxes on profits. Tax-exempt savings and investment products help maximize returns by reducing taxes. As government policies evolve, new tax-exempt products are introduced, so keep an eye out for them and actively use them to accelerate your asset growth.
I have compiled a list of tax-exempt investment products in the following section for your reference.
The Best Investment Is in Yourself.
In the workplace, some people constantly check stock prices on their smartphones or work computers during business hours. These individuals often neglect their actual job responsibilities.
The best investment you can make is in yourself. If you’re an employee, the best investment is to excel in your current role and increase your value. If you’re a business owner, the best investment is to focus all your efforts on growing your business.
Investment and financial planning should support the wealth generated from your primary occupation. If you let investment take over your life and invest too much energy into it, you are likely to incur losses in the end.
9. Tax-Exempt Investment Products
1. Individual Retirement Pension (IRP)
Features: A retirement pension plan that individuals can join.
Tax Benefits: Tax deductions on annual contributions up to a certain amount. Lower tax rates apply when receiving the pension.
Investable Assets: Funds, stocks, bonds, and various other assets.
2. Retirement Savings Account
Features: A savings account for individuals to accumulate funds for retirement.
Tax Benefits: Contributions are eligible for tax deductions up to a certain amount. Lower tax rates apply at the time of pension withdrawal.
Investable Assets: Funds, stocks, bonds, and various other assets.
3. Individual Savings Account (ISA)
Features: A comprehensive asset management account that allows individuals to manage various financial products within a single account.
Tax Benefits: Tax exemption on income generated within the account, up to a certain limit.
Investable Assets: Savings, fixed deposits, funds, stocks, bonds, and various other assets.
4. Long-Term Housing Savings
Features: A savings product designed for accumulating funds for purchasing a home.
Tax Benefits: Exemption or reduction of interest income tax after a certain period of deposits.
Investable Assets: Primarily savings products such as fixed deposits and installment savings.
