What is investing?
“It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.” – Robert Kiyosaki
Investing is the act of committing money or capital to an endeavour with the expectation of obtaining additional income or profit in the future. The additional income or profit earned from investing can be in the form of rental income, interest earned, dividend or capital appreciation. When investing, investors should consider their investment goals, risk/reward relationship, risk tolerance level, and investment vehicles/asset classes, before making any investment decision.
Saving versus Investing
Savings refer to money put aside for future use rather than spending it immediately. For example, the purchase of a new smart phone, an automobile, or paying for a vacation can all be accomplished by saving a portion of one’s income. On the other hand, investing is the process of using money/skills to acquire an asset (physical/financial) with a high probability of generating an acceptable rate of return over time.
Investments can be in art works, jewellery, stocks, bonds, real estate or assets that an investor believes will produce income. For example, John uses some of his salary to buy shares on the Stock Exchange, with the hope of receiving dividends and bonus shares at the end of the year.
The major difference here is, while savings can be seen as the mobilization of funds, investing is putting the funds or savings to productive use in order to increase wealth.
Risk versus Reward
Risk is a situation where there is exposure to harm or probability of loss. The compensation for risk taken is ‘’Reward’. Usually, there is a direct relationship between the risks taken and the outcomes, that is, the rewards/returns, all other things being equal. However, there is no guarantee that you will actually get a higher return by accepting more risk. Diversification is a risk mitigating tool that enables one to reduce the risk in one’s investment portfolio.
“Never depend on a single income, Make investments to create a second source”– Warren Buffet
Risk Tolerance and Profiling
Risk tolerance is the level of unpredictability in returns that an investor is willing to withstand. An individual’s risk tolerance level changes over the individual’s life cycle, depending on factors such as, Age, Income, Financial literacy and Lifestyle.
Risk profiling is vital in investing and is modified as the individual’s circumstances change. It enables an unbiased evaluation of an individual’s risk tolerance (willingness and ability to take on risk)
Your ability to take on risk depends on your surplus or earning capacity and can be quantified primarily through your net worth. Time horizon, level of market sophistication, and expected income influence your ability, while your willingness to take risk depends on factors such as personality type, self-esteem, investing experience, and resiliency.
For example, a retiree might be less willing to take risk, as a result of limited understanding of financial markets. However, risk tolerance does not always depend on the factors listed above. Some investors in retirement might have a high risk tolerance, whilst some young investors might have a low risk tolerance. So, understanding yourself and your investment objective are key.
Financial Asset Classes or Investment Vehicles
Understanding financial markets and the different financial asset classes available for investing, is important. In Nigeria, there are four main asset classes; Money Market Instruments, Bonds, Equities Foreign Exchange and Real Estate. A thorough understanding of the risk associated with each asset class is crucial when making investment decisions and tracking investment returns.
Financial Assets/Investment Vehicles
- Money market instruments: These are short-term investments that have maturities of less than one year and are highly liquid. This asset class usually gives better interest rates than savings accounts. Examples of Money Market Instruments are Treasury Bills, Bank Placements, and Commercial Papers.
- Bonds: These are long term debt obligations issued by Sovereigns and Companies when they want to borrow money from investors. Returns are paid periodically (quarterly, semi-annually or annually) in form of coupons. For Example, Federal Government Savings Bonds and Corporate Bonds.
- Equities: They confer ownership of a stake in a company. The company might either be publicly listed on a stock exchange such as the Nigerian Stock Exchange or be unlisted. Listed equities are generally easier to buy and sell. You can potentially make money from equities either through capital gains, dividends or bonus shares.
- Real Estate: The term real estate means real or physical property. Real estate investing involves the purchase, ownership, management, rental and/or sale of properties for profit. Indirect exposure to real estate can be achieved through Real Estate Investment Trusts.
In summary, all investments have an element of risk. However, the level of risk varies with different asset classes. Once you know your risk tolerance and understand each asset class, you can then invest in one or multiple asset classes.
In addition, if you don’t have enough knowledge, cash, time or experience to acquire and monitor the financial assets mentioned above, you can gain exposure to these assets via Collective Investment Schemes managed by reputable Fund Managers.
“The question isn’t at what age I want to retire, it’s at what income”—George Foreman
The reward and impact from investing cannot be overemphasised. It is never too late to start investing and adopting an investment culture through financial planning, continuous net worth evaluation and goal/target-based investing. Overall, an effectively managed investment lifestyle usually leads to financial growth, wealth maximisation and a happy life.
By Fund Managers Association of Nigeria