Oran Hall | Taking the plunge

ADVISORY COLUMN: PERSONAL FINANCIAL ADVISER

QUESTION: I am 28 years old. I have always wanted to invest but do not know how. I read your article that was in the paper. I would love your guidance on where to start investing. Where should I look?

– Antonio

FINANCIAL ADVISER: To invest is to acquire an asset to get a return, which could be in the form of income, capital gains, or both. Because investors are so different from each other and have so many varying objectives, and the instruments vary so much, there are different approaches to investing.

Income comes primarily in the form of dividend, interest and rent – from shares, bonds and other interest-bearing securities, and real estate, respectively. Capital gains arise when the market value of an asset increases above its cost price but is only realised when it is sold. Until then, the market value may rise or fall from time to time depending on market conditions.

Investors have many varied needs which they try to satisfy by investing. Additionally, the time between when they invest their funds and need to use them to meet their goals varies – and widely, too. Some investments are for the short term, but others may be medium-term or long-term.

Investors would generally invest their funds for different periods and invest in several types of investment instruments and in several different instruments. The collective group of an investor’s investments is called a portfolio, the return of which depends primarily on how it is structured, that is, what portion of the funds is in the different types of investment instruments.

Risk is a very important consideration in putting in place and maintaining an investment portfolio. Risk is the chance that a portfolio or an investment instrument may not give the expected return, the worst-case scenario being that the investor may suffer a loss.

Investors who are not comfortable with risk, because of the likelihood of them not realising the level of return they expect, are said to be risk-averse or are low-risk investors. High-risk takers are comfortable with risk – sometimes too comfortable – and are prepared to go for high returns, although this means they could conceivably lose heavily.

In investment language, this is expressed as there being a direct relationship between risk and return. Low-risk instruments give a low return and high-risk instruments give a high return, but may also give a low return or even a negative return.

Risk tolerance

A significant difference between instruments that are low-risk and those that are high-risk is that the former offer a greater level of security of principal, meaning the investor can expect a return of the principal sum invested.

Short-term fixed income instruments are the best for safety of principal, and long-term bonds held to maturity are also fit for this purpose. The major downside of such instruments is that, the longer they are held for, the less the principal sum is worth because of the loss of purchasing power caused by inflation.

The instruments like ordinary shares and real estate, which have the capacity to appreciate in value over time, can potentially protect the investor’s purchasing power and give a real return, that is, a return that is higher than the rate of inflation.

It is unwise to put too much of your money in one type of investment instrument, but there are two types of instruments which allow investors to make one investment but to share in the ownership of several instruments and types of instruments.

The investment funds are such that investors should be able to find a fund suitable to their needs and risk preference. These are called unit trusts and mutual funds and are managed by professional investment managers for the benefit of the investors, who are freed from the everyday hassle of managing a portfolio.

Before you commit to an investment programme, you should determine what you want to achieve most. If you want to get a regular flow of income, then bonds and other instruments that pay interest are good for you. Ordinary shares are good if your primary goal is to have the value of your investment grow, primarily over the long term.

Money market and bond unit trusts and mutual funds will not give you cash income, such as interest, but they offer safe, steady growth. On the other hand, the capital growth funds of unit trusts and mutual funds are potentially good means for generating capital appreciation.

One advantage of mutual funds and unit trusts is the relative ease of converting them to cash, compared to shares, for example. Another advantage is the scope they offer investors to participate in the ownership of assets like real estate and assets in other countries, depending on the type of fund the investor selects.

Where you start depends on what you want to achieve, the risk you are able to take, when you want to realise a return and the type of return, and whether you have the time and skill to manage the portfolio yourself. For further help, turn to the telephone directory under ‘Investment Advisory and Securities Service’ for a list of stockbrokers, fund managers, unit trusts and the only Jamaican mutual fund.

Oran A. Hall, principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.

finviser.jm@gmail.com