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The best way to in­vest

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QUES­TION: I have some funds avail­able. How is the best way to in­vest them?

– Ho­race

FI­NAN­CIAL AD­VISER: I wish I could give you a di­rect an­swer. My an­swer is: It de­pends. It de­pends on your in­vest­ment ob­jec­tives, your risk tol­er­ance, your time hori­zon, the rest of your port­fo­lio, the re­sources you have to in­vest, your knowl­edge and un­der­stand­ing of in­vest­ments, your place in the life cy­cle, and your goals.

In­vest­ment ob­jec­tives in­clude reg­u­lar in­come, preser­va­tion of cap­i­tal, growth or cap­i­tal ap­pre­ci­a­tion, ease of man­age­ment, ex­change rate hedge, liq­uid­ity or ease of con­vert­ing to cash, diver­si­fi­ca­tion.

Your ob­jec­tive in­flu­ences your choice of in­stru­ment and some in­stru­ments may sat­isfy more than one ob­jec­tive, but there is usu­ally one that is best for a par­tic­u­lar ob­jec­tive.

For reg­u­lar in­come, bonds are best. The in­come earned from bonds is in­ter­est. Div­i­dends from stock may pay reg­u­lar in­come, but this is not guar­an­teed.

Bonds are also good for preser­va­tion of prin­ci­pal in the sense that you are likely to get back all the cap­i­tal you in­vest. This is gen­er­ally the case if you hold them to ma­tu­rity. But if you sell be­fore then and in­ter­est rates rise above the lev­els ex­ist­ing at the time you made the in­vest­ment, you are al­most cer­tain to lose some of your cap­i­tal but should gain if in­ter­est rates fall in­stead.

Unit trusts and mu­tual funds that in­vest in bonds and other in­ter­est-earn­ing fi­nan­cial in­stru­ments are also good for preser­va­tion of cap­i­tal. Some also dis­trib­ute in­come, so they would be good for reg­u­lar in­come.

If you want cap­i­tal ap­pre­ci­a­tion to hedge against in­fla­tion, stock and se­cu­ri­ties linked to real es­tate are suit­able. Unit trusts and mu­tual funds that in­vest in these se­cu­ri­ties are also suit­able. Some unit trusts and mu­tual funds also in­vest di­rectly in real es­tate.

If your risk tol­er­ance is low, that is, you do not have the ca­pac­ity to tol­er­ate fluc­tu­a­tions in the value of your in­vest­ments, bonds are best for you. You would hardly be com­fort­able with in­vest­ing in stocks and per­haps real es­tate and as­so­ci­ated in­stru­ments. On the other hand, you would be com­fort­able with them if your risk tol­er­ance is medium to high.

Ease of man­age­ment refers to main­tain­ing a port­fo­lio of in­vest­ments with­out hav­ing to man­age them on a day-to-day ba­sis. Unit trusts and mu­tual funds are very suit­able for this pur­pose. This func­tion is un­der­taken by pro­fes­sional fund man­agers. They make the buy­ing and selling de­ci­sions and at­tend to other mat­ters re­lated to the man­age­ment of the port­fo­lio.

If you want pro­tec­tion against the lo­cal cur­rency los­ing its value, in­vest in in­stru­ments with a for­eign cur­rency-earn­ing com­po­nent, which span vir­tu­ally all in­stru­ments in the mar­ket­place.

Liq­uid­ity refers to the abil­ity of an in­stru­ment to be con­verted

to cash easily, that this, the con­ver­sion to cash can be ac­com­plished in a rel­a­tively short time at or close to its value. Bonds gen­er­ally fit this ob­jec­tive quite well.

If you want a diver­si­fied port­fo­lio, you may in­vest in sev­eral types of se­cu­ri­ties. The eas­i­est way to ac­com­plish this, though, is to in­vest in unit trusts or mu­tual funds. There are many types of these in­stru­ments to meet ev­ery ob­jec­tive you may have.

Time hori­zon refers to whether you will re­quire the funds in the short, medium, or long term. Nowa­days, the time line as­so­ci­ated with these is much shorter than I was used to in the past, but I am pre­pared to ac­cept short term as up to two or three years; medium-term, over that and up to 10 years; and long term, any­thing above ten years.

Bonds fit all the above. It is their ma­tu­rity date that mat­ters. Unit trusts and mu­tual funds can be con­verted to cash quite easily, but it is ad­vis­able to treat them as long-term in­vest­ments. Stock may yield good yields in the short term, but it is best to treat it as long-term.

If you al­ready have an in­vest­ment port­fo­lio, it is im­por­tant to see how new in­vest­ments would fit into it. The ex­perts will tell you that as­set al­lo­ca­tion has a stronger bear­ing on the per­for­mance of your port­fo­lio than se­cu­ri­ties se­lec­tion. The se­lec­tion you make should not dis­turb your as­set al­lo­ca­tion or the pro­por­tion of your port­fo­lio in the var­i­ous types of in­vest­ment in­stru­ments.

If the re­sources you have to in­vest are small, it is ad­vis­able to in­vest in unit trusts or mu­tual funds be­cause the min­i­mum sum ac­cepted for in­vest­ment tends to be less than for other types of in­stru­ments.

Ad­di­tion­ally, if you have lim­ited funds, it is ad­vis­able to avoid more risky in­vest­ments. Per­sons with more re­sources are bet­ter able to with­stand losses.

Your age will have some bear­ing on your de­ci­sion. The younger you are, the more time you have to re­cover from your losses, but the smaller the pool of funds you are likely to have and the less you are likely to know about in­vest­ments, so your risk tol­er­ance may be low. At the other end, the nearer you are to re­tire­ment, the less risk you can af­ford to take.

If your knowl­edge of in­vest­ments is lim­ited, it is pru­dent to avoid the more com­pli­cated in­stru­ments such as struc­tured notes.

Im­por­tantly, what is your goal? This will have some bear­ing on your time hori­zon, in­vest­ment ob­jec­tives, and your strat­egy.

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

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