Oran Hall | Taking the first step towards investing
QUESTION: I want to invest, but I don’t know what company to invest in and how to. I don’t know where to start, but I know I would like to make a step towards some kind of investment that can turn over money short term.
FINANCIAL ADVISER: To invest is to use money to make a return – in the form of income (interest, rent, dividend), capital gain, or both.
Investment vehicles include securities – tradeable financial instruments such as bonds, debentures, preference shares, and ordinary shares; physical assets like real estate; and commodities such as gold.
It is important to understand several things about investing before making a commitment to invest. The price of investment instruments is determined by demand and supply in the market, so investors may make gains or losses. Risk, the possibility that the return the investor expects may not be realised, is an essential part of investing.
Potential investors should understand that investing is long term. Notwithstanding the short-term price fluctuations, over the long-term, the price of investment instruments tend to increase.
Considering the short-term risks associated with investing, investors should not commit short-term funds to investing, so money needed for day-to-day expenses should not be invested. Short-term funds are best placed in short-term instruments for a term that matches when the funds are needed.
It is also important to note that some instruments are more sophisticated than others. Investors should stay away from instruments they do not understand even if the investment professionals are very convincing when making their recommendations.
To be better able to make meaningful investment decisions, investors should have some understanding of the instruments they are committing their funds to, so they should do even some elementary research and ask their investment advisers serious questions about the recommendations they make.
People who do not have resources and lack sophistication in investment matters ought not to borrow to invest.
Investing requires time: to do research, to follow what is happening on the market, and to take care of administrative matters pertaining to the portfolio such as ensuring that they receive distributions such as interest and dividends.
Unless there is a formal arrangement for professionals to manage a portfolio, investors should take full responsibility for making decisions, not depending on receiving calls about buying and selling securities from investment professionals.
In the case of securities, some are safer than others. Bonds and debentures, for example, tend not to lose significant value. If they are held to maturity, generally, there is no loss of capital except in the cases in which they are bought at a premium. In such cases, though, it is hardly reasonable to speak of a loss as the price is calculated to give the investor the yield to maturity agreed at the time the investment is made.
Even when there is no loss of principal, the investor does make a loss, not in money terms, but in real terms, that is, after taking into consideration the loss of purchasing of the principal invested due to inflation.
Bonds and debentures that are sold before their maturity date may lead to gains or losses, depending on whether interest rates decline or increase between the time of purchase and sale.
It is also possible that the issuers of debt securities like bonds and debentures may not be able to pay contractual interest payments and even the principal at maturity.
Ordinary shares, commonly called stocks, to which you seem to be referring, tend to give good returns over the long term. Although their prices may rise sharply in the short term, investors should avoid believing that this will always happen and recognise that they can make big losses from stocks.
Dividends, paid out of the net profit of the companies up to four times per year, sometimes provide a good source of income. Some companies, though, prefer to retain much of the profit in the business for future growth, which ultimately benefits the shareholders when profits increase consequently.
Like bonds, there are few preference share issues on the local market although they tend to be a good source of income and tend to maintain their value well.
Real estate requires deep pockets, but investors have the option of investing in real estate investment companies, which are listed on the stock exchange.
Unit trusts and mutual funds, which pool the money of many investors to invest in several investment instruments, provide some protection against loss of principal, some types more than others, but those that invest for capital gain may see losses in the short term. They are professionally managed and are easily converted to cash.
If you change your mind about wanting to realise short-term gains, these may be the best instruments to start with, and you do not need a significant sum to start. The Financial Gleaner publishes a comprehensive report on them weekly.
A stockbroker can give you guidance on shaping a portfolio. The Investment Advisory and Securities Service section of the telephone directory will help you identify several investment service providers.
- Oran A. Hall, principal author of ‘The Handbook of Personal Financial Planning’, offers personal financial planning advice and email@example.com