Stocks or money in the bank? What's better?

QUESTION:

I have about $7 million locked up in an account getting paid at 2.75 per cent per annum. Should I break the terms and conditions and put it on the JSE at a better rate? What do you think?

PFA:

The stock market is not a place where you put money to get a "better rate" as you put money on deposit in the bank. It promises no rate, offers no guarantee, and is not the place for the risk averse.

Having your money in the bank has several advantages. It is easy to manage; leave your money and collect interest or roll it over at maturity if it is on fixed deposit. If it is a savings account, just let it earn interest and make withdrawals when you need money.

The rate you will earn is known, you know the maturity date if it is on fixed deposit, and it is more or less quite safe. There is limited protection through the Jamaica Deposit Insurance Scheme but how much compensation flows to you depends on how many different kinds of accounts you hold and in how many financial institutions they are if your funds are at risk.

Disadvantages

There are disadvantages. Rates are low; there is no capital growth and, therefore, no inflation protection. Furthermore, interest earned is taxable, which effectively reduces your yield.

There are advantages to owning common stock. Neither the dividends nor capital gains are taxed - giving a strong boost to the yield, and because of the ability of stocks to appreciate in value, they are a good hedge against inflation.

What are the disadvantages? Stock prices do fall, so there is no assurance that you will not lose some of your principal. There is no certainty that you will receive a dividend but, even then, dividends tend to be quite low and are not generally paid more than once or twice per year. It is not easy to manage a stock portfolio; it requires time and expertise. All stocks do not have the same level of liquidity but it is fair to say that it can sometimes be quite difficult to sell even good stocks.

It is important that you choose investment instruments that are suitable for you. If you have a low tolerance for risk, the stock market is not for you. If your objective is investment income, the stock market is not for you. Do not make the mistake of trying to get rich overnight.

Your best bet is to decide what your life goals are and to put a cost to each, taking care to determine when you would like to achieve each goal. Your financial plan is what supports your life plan. Aim to make the best return possible at the level of risk you are comfortable with. If you are not comfortable with the stock market and prefer interest-earning investments, seek investments that pay relatively good rates without exposing yourself to too much risk.

You should not be afraid to shop around to identify where you can get relatively good rates. The unit trusts that invest primarily in interest-earning securities have been recording much better returns than 2.75 per cent. You need to diversify your investments generally. If, after consulting with a qualified and competent investment adviser or manager, you are satisfied that you have the capacity to invest in the stock market, you should invest only a portion of your funds there. It is important to diversify your portfolio to reduce risk. For someone who seems to know very little about the stock market, it is best to make the move into stocks by investing in a unit trust that invests in stocks.

This approach gives you a portfolio that is diversified and which is managed by professionals who have more time and expertise to manage your investment than you do. It is quite easy to sell your units so you should not have a problem with liquidity, and it is just as easy to make the investment.

There is a cost, though. The management companies of the unit trusts levy several fees on the funds and sometimes take a spread, meaning there is a difference between the buying price and the selling price.

You have several options. Be careful and deliberate in making your decision. You deserve better than 2.75 per cent but the solution is not necessarily the stock market.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of 'The Handbook of Personal Financial Planning', offers free counsel and advice on personal financial planning. finviser.jm@gmail.com.