Firstline Presents…Investment 101

There are many reasons to invest and for every reason there is an appropriate avenue or instrument that can be used to help the potential investor meet their goals.

The objective of this piece will be to provide clarity on some of the most basic issues and questions faced by persons as they make investment decisions. Note that investment in the context of this blog refers to the act of putting money into a financial scheme, shares, property or a commercial venture and other financial securities with the expectation of achieving a return either in the form of periodic distributions, capital appreciation or some combination of both.

Why Invest?

To purchase a car or a house, to send a child to university, to plan for retirement or to simply accumulate wealth: these are just some of the reasons one should invest and not just save.  Investing allows for the savings to earn as the investor moves closer toward achieving their investment outcome.

Savings involve the accumulation of financial wealth without the explicit goal or targeted use for the accumulated funds. Savings normally do not earn any revenue, whereas investment involves allocating money to assets that can earn either through cash distributions or capital gains thereby creating value for the investor. There is a theory which suggests persons should only invest their “extra” capital.

What is extra capital? Let’s assume a person “saves” 10% of their monthly income of $12,500 per month. They would then be saving $1,250 per month or $15,000 per year. Allowing this money to accumulate in a “cash pan” at home or a “sou-sou” or a regular savings account creates zero additional value; in some cases it may cost the individual a direct cost of an account maintenance fee or the indirect cost of inflation, where the spending power of the $15,000 declines by the time the money is fully accumulated.

Using the same example above: Tom wants to buy a new car.  He decides to save for two years to make up the down-payment of $30,000.

Tom can “save” the $1,250 per month for the next two years and then make the required down payment. However, after the 24 months, the price of the car has increased, and the minimum down-payment has increased to $32,500. Tom will be forced to wait two more months before he could purchase the car.

What if Tom placed his monthly contributions into a Mutual Fund or Wealth Management account with an investment firm. Tom’s contributions would be earning for every month he contributed. Let’s assume the annual returns were 7% per year or 0.57% per month. Tom’s investment would be worth $32,051 after two years at this point, he would be less that $500 short of his intended target.

While the case may have illustrated why we should invest, it may have raised as many concerns as those it answered. For example, how would Tom know by how much car prices would increase in two years? Or how would he be able to effectively find an investment vehicle that would help him with his return objectives. What risks would Tom be willing to take in order to achieve his investment return. Also, what if the investment loses value during the two-year period? These are all valid concerns that Tom and all investors should have prior to committing to any investment.

Investing seems scary whereas savings is simple and safe.

Based on all the new concerns Tom now faces after choosing to invest rather than save, it may be logical for Tom to be reconsidering his choice.

Investing seems to come with a host of “what abouts?”.  What about risk? What about fees? What about ethics? What about fixed income vs equity or any other alternative investment securities? What about the economy?  What about the stability of the investment firm? It seems like the questions and the factors to consider are limitless.

The reality is though – this is life! We face new risks every day. We pay fees for everything we use: gas and maintenance for our cars or a taxi fare to travel.  Most of these issues are part of our daily lives and we navigate them continually. Yet we treat our hard-earned money like it’s someone else’s responsibility to manage and to benefit from as long as they keep it “safe”.

Savings on the other hand is simple. We join a sou-sou, accumulate money under our mattress or open a savings account at the local bank. These seem like safe options, well at least until the person running the sou-sou disappears or half of the people in the sou-sou bail after receiving their “hand”. Or our house is burglarised, or God forbid something worse such as a flood or fire.

What about the local bank? Surely with deposit insurance up to some maximum limit savers can feel secure? Well the deposit insurance does not compensate for inflation nor does it cover the exorbitant bank fees that are consistently charged to the account. All things considered, savings may carry more hidden risks than investing especially when one considers that savings do not generate a return on the money saved in the main or at best a miniscule return eroded by inflation.  Savings’ purpose is to provide liquidity, not returns.

Investors should not be afraid to ask questions and engage institutions about investment services. At Firstline Securities we have skilled professionals who can answer investment related questions, provide sound advice and manage your investments to “create wealth for you”.