What you need to know about investing
published: Sunday | January 22, 2006

Hopeton Morrison, Contributor

IT IS an opportune time to revisit a few basic investment considerations as we focus on the remaining 11 months of 2006. We consider some of the crucial principles that guide prudent investment decisions for lifelong financial independence.

Investment is theoretically driven by three principal factors. These are safety, liquidity and returns.

SAFETY

Safety simply means that one should be able to sleep peacefully at nights knowing that his investments are not at risk. And although safety ought to be the primary driving force in investments, local and international experiences in the not too distant past have shown that some investors are not averse to taking major risks with their money. The age old adage reminds us that the higher the risk the higher the potential returns or losses.

This risk/return dynamic played out in the international capital markets in recent times when millions of investors went on an almost hysterical binge into telecommunications and computer stocks in what was widely called the dot.com binge.

The entire dot.com hysteria turned out to be nothing more than what in the financial vocabulary is commonly called a bubble. Stated simply a bubble represents an irrational affection for a particular industry's investment opportunities often driven by perceived notions of unusual and quick gains to be had. Millions of these investors lost several billions of dollars as a result of the collapse of the dot.com bubble. The moral here is that investors need to be very watchful of these perceived miracle industries that everyone else seems excited about. History has shown that more often than not the herd is going in the wrong direction.

LIQUIDITY

The third factor in the investment discussion is liquidity which means that the funds are available when needed. If one, for example, invests in a five year instrument it means that these funds will not be accessible under five years unless the investor is prepared to sell at a discount.

So for liquidity purposes prudent investors structure in such a way that funds are available to them as needed. That means investing some funds short term, such as an emergency fund and some invested further on the continuum, such as needed for purchasing a car, house or preparing for the children's education.

At the end of the continuum is one's retirement nest egg. All of this explains why adopting the budgeting habit is so crucial for serious personal financial planning.

There is one further consideration in all of this. Prudent investment speaks to sensible diversification of a portfolio. The most common options are:

Fixed income or money market funds.

Real estate.

Your own business or the entrepreneurship option.

Investment in equities.

Fixed income or money market funds are theoretically the safest of the lot. Locally, money is invested into quite secure government paper and one is assured of a stated return at the point of investment. Although rates have been on the decline since the latter stages of 2003 and investors have experienced negative real returns in 2004-2005 (that is negative returns after inflation and taxes are computed), prudence demands that at least some fixed income investments form a part of every portfolio.

Real estate is increasingly becoming an attractive investment option again but potential returns here are heavily muted by the onerous taxes, charges and duties that are tied to this investment.

Finally, a word for young people. Young people carry a very significant advantage in the investment decision process. Young persons are in a position to create enormous material wealth for themselves because they can take risks that an adult of say 45 with a family to care for cannot take.

Mid-career adults with major school and college bills either on their hands and or on the horizon, with perhaps a mortgage to pay off, motor car loans, swimming and karate classes for the children, will carry a risk quotient significantly below that of the average young person.

There are just too many dependants that will be affected if high-risk investments backfire as they can, at that stage of life. On the other hand, young persons don't need to be constrained by those considerations. For the young, therefore, significant investments in equities is par for the course.

Hopeton Morrison is general manager of St. Thomas Cooperative Credit Union Ltd. and lecturer in the School of Business Administration at the University of Technology. Please send comments and questions to: hmorrison@stccu.com.