Making investment decisions

QUESTION:  I would like to know the criteria for determining a good instrument to invest in. Also what is your advice on investing in real estate?  I am a 27-year-old health professional. My husband is 30 and a professional in the IT and education sectors. We have no children and do not own a home at the moment. We both have regular savings accounts, insurance policies, and retirement plans. Our short-term goals include paying off our car loans, having our first child, and perhaps owning a home.

- T.Parchment

PFA:

A good place to start is where you ended your letter. You should know what your objective for investing is before you determine the type of instrument most suitable for you and then select instruments of suitable quality within the asset classes you have chosen.

You have identified two of your short-term goals and raised a third that you seem to be less certain about. I suggest you go beyond identifying your goals and set a specific timeline for achieving them so that you can put a proper programme in place and set measurable targets.

Liquidating your debts would likely leave you with less funds to invest in the short-term but, if you are not able to make a higher return on your investments than it is costing you to service your debts, liquidating them may be the best course to take.

The addition of a child to a family is a costly matter which inevitably leads to a steady long-term stream of expenses. In the event that the child comes according to your timetable, it should be clear to you that you will likely have a reduced amount of funds to invest unless you are able to increase your income above the level of the additional expenses.

It is all right to want to own a home. The real challenge is usually to source the deposit and the closing costs. A big advantage is that your equity in your property grows over time and, as your income grows, the mortgage becomes more affordable.

The same arguments hold for a real estate investment - which is a good inflation hedge - but you should note that you could face some cash-flow challenges if you are not able to rent or if the rent is not sufficient to pay your mortgage.

How do you make your investment decisions? A good investment instrument is one that matches your objectives. If you want income, bonds are the most suitable because they provide a reliable income stream. If, in addition to income you want liquidity, you need liquid instruments such as short-term interest-earning securities or short-term securities like Treasury bills that sell at a discount.

Money-market unit trusts do not pay interest but they are very good for liquidity and increase steadily in value as income earned is reinvested.

If your objective is to increase the value of your capital, the vehicles to use are real estate, equities, and unit trusts that invest for capital appreciation. There is not much more that our market has to offer now.

A good bond is one whose issuer has a sound financial Government bonds generally find favour with investors even when the economy is struggling. But corporations do not have the luxury of being able to increase taxes.

You must, therefore, satisfy yourself that the issuer of the corporate bond can repay the debt at maturity and pay interest when it is due.

You may want to satisfy yourself that there are sufficient and good assets securing the debt, that there is a sinking fund in place to retire the debt, that the ratio of debt to equity is reasonable, and that the earnings and cash flow are adequate to pay contractual interest payments.

A major consideration when investing in ordinary stocks is the profitability of the company and its ability to increase profits at a satisfactory level in the future.

It is important to know that the company has good management and good plans for the future, that it has a solid place in the market, and that it does not have too much debt. You may also want to know if it pays good dividends and if its stock price is reasonable relative to its earnings.

As in the case of a stock, past performance is no guarantee of the future performance of a unit trust but it can serve as a useful guide. Compare unit trusts with others of the same type.

Look for consistent historical returns and read their offering circulars to learn about them, making sure to look at their investment policy.

Ask a professional for help if you need to.

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.