My Money

Olebile Makhupe | Monday July 12, 2010 00:00

 We discussed that the minimum investment amounts can be reasonable making it possible for most Batswana to invest in bonds. On the larger scale of things, how does one align their investment goals with the type of investment they make, such as buying bonds?

The clich 'knowledge is power', actually carries a lot more weight than we accredit to it. The more knowledge you have on any matter that affects you, the better you are able to make decisions that are right for you. In fact as most of us may have observed, knowledge can indeed directly translate to financial gain or wealth. You are able to spot investment opportunities or identify the right investment strategy for yourself only when armed with information.

How many of us currently have pension plans? If you have one where your employer may be generous enough to contribute a certain percentage, do we know how much they actually contribute? Some employers even provide incentives for employees who increase their contribution- do you know if your employer has such an arrangement? Most importantly, do you know what your pension payout plan is? Upon retirement, will you maintain the standard of living you had while employed?

The type of investment that you choose for planning your financial future should largely be influenced by when you are planning to access your savings, your risk appetite and whether you can afford volatilities in your returns. For those who have pension plans or financial advisors, it is therefore important that you understand fully where and how your money is being invested. With recent crashes in stock markets, many who had short-term uses for their funds lost out in a big way, with others who were looking to retire fairing even worse since they did not have enough to live on, with the erosion in their investments. It is therefore important that you learn a very important lesson called asset allocation.

Asset AllocationAsset allocation describes the percentage of total assets invested in different investment categories, also known as asset classes.

 The most common broad financial asset classes are stocks (or equity), bonds (fixed income) and cash. Real estate, precious metals and 'alternative investments' such as hedge funds and commodities can also be viewed as asset classes.

Each broad asset class has various subclasses with different risk and return profiles. In general, the more return an asset class has historically delivered, the more risk that its value could fall as well as rise because of greater price volatility. To earn higher potential returns, investors have to take higher risk.

RiskStocks are generally considered a risky investment because, among other things, their values can decline if the stock market goes down (market risk) or the issuing company does poorly (company risk). As owners of the company, stockholders are paid after all creditors, including bondholders, are paid. In theory at least, a stock's value can go to zero. Historically, stock prices have been the most volatile of all the different types of investments, meaning their prices can move up and down quickly, frequently and not always in a predictable way.

Bonds are considered less risky than stocks because bond prices have historically been more stable and because bond issuers promise to repay the debt to the bondholders at maturity.

That promise is generally kept unless the issuer falls on hard times; some bonds have credit risk based on the financial health of their issuer. When a bond issuer goes into bankruptcy, bondholders are paid off before stockholders. Bonds are also vulnerable to interest rate risk: when interest rates rise, bond prices fall and vice versa.

Cash investments carry opportunity risk. For example, investing in very safe, short-term investments like Treasury Bills may protect you from loss, but you may miss the opportunity of more generous returns offered by other investments. Even people who keep their money under their mattress have the risk that their money will be worthless in the future because of inflation that reduces the purchasing power of the cash.

Why Allocate?Smart investors do not put all their assets in one type of investment or 'asset class.' Instead, they spread or diversify their risk by investing in different types of investments. When one asset class is performing poorly, another may be doing well and compensating for the poor performance in the other.

Some studies have shown that overall asset allocation is more important to investment success than the choice of investments within the allocation.

'Model' Asset AllocationsInvestment firms often publish recommended asset allocations based on their outlook for the relative performance of the stock, bond and money markets.

The asset allocation that is right for you, however, depends on several personal factors, such as life and financial goals, and will change over time with different life events.

Personalise, review, revise as neededOnce you establish your optimal asset allocation which takes into account return objectives, risk tolerance and time horizon, you need to review your investments regularly to see if your portfolio matches your plan and if your plan is still right for your age and goals. When one asset class performs well or poorly, it can shift your asset allocation.

You can bring it back in line by 'rebalancing' or selling assets that have appreciated and buying those that have fallen in price. In this way, asset allocation enforces a good discipline of selling high and buying low.

Younger investors may want to allocate their longer-term retirement assets to riskier investments such as equities or stock, because they have time to ride out the market's ups and downs.

With age, however, asset allocations may shift toward safer investments such as bonds because retirement is getting closer and older investors should be more concerned about keeping what they have saved and gained.

Take time every six months to a year or two to be sure your asset allocation still matches your plan and that your plan remains appropriate for your age and goals, giving yourself the opportunity to rebalance if there is need to. Your investment advisor can help with this process.

Source: The Securities Industry and Financial Markets Association

Olebile Makhupe is the Head of Global Markets at Standard Chartered Bank Botswana. For feedback and contributions, please e-mail: mymoney@mmegi.bw