By: Barbara Mundell CFP®, Technical Specialist at the Financial Planning Institute
Investments are complex by their very nature. Everyone is constantly looking for ways to make their money work for them. In the last few months there has been numerous schemes promising high returns but at what risk?
The old rule of the higher the return the higher the risk should not be overlooked when choosing your investments. Here are three questions you should ask yourself or anyone assisting you with your investments.
Where is my money invested?
In economic markets there are four different asset classes, namely money, bonds, equities and property.
Money typically refers to bank investments like a savings accounts, 32 day notice accounts, or money market instruments. These accounts usually offer a relatively low rate but the possibility of losing your initial capital is very small.
Tip when shopping around; ensure that you have an understanding of the type of rate they offer. Nominal rate is often lower than the effective rate because it is not taking into account the compounding effect of your interest.
Bonds refer to a debt instrument that the government and corporate companies use to raise funds. You will invest your money, and in return you will receive interest, depending on the type of bond, it could be monthly, quarterly, half yearly or annually. You would normally also commit to a term that you agree to have your money invested for example 3 years.
The Johannesburg Stock Exchange (JSE) has a section where bonds are traded. Bond holders use this market to sell their bond instruments at a discounted price because they need their funds sooner than expected.
Equities are stocks listed on the JSE. Shares are bought and sold on a daily basis. Share values differ daily and will have a closing price once the market closes every day. Most South Africans use Unit Trust Funds to invest in the share market due to the cost involved. A unit trust combines the funds received from all investors to then invest in the stock market.
Listed property works a lot like unit trusts, except the companies that you buy the shares in, invests in shopping centres office blocks and commercial properties. They then rent the properties out to tenants to generate an income.
What makes my money grow?
Recently the HAWKS indicated that they are investigating various schemes as being pyramid schemes. It is not always easy for people to identify if an investment is a pyramid scheme or not.
If you understand how your money generates the return or growth, it might be easier for you. I’m going to use a few examples to highlight how your money will grow.
A bank will use the funds in your account to lend to others. They then charge interest which they then pay over to you. If you invest in unit trusts, you are in actual fact buying shares. Once the shares are bought they are then traded on a daily basis.
When invested in shares, your income can be obtained from two sources. The first source of income would be from the daily change in the share price; as the price grows, you are able to sell your shares at a profit.
The second source of income will come from dividends that the listed companies pay investors when they release their annual results. This however is not always guaranteed. The reason most share prices drop dramatically is due to some listed companies not declaring dividends when investors expect it. Dividends are normally paid from the profits made, that is why in tough economic times the dividends are lower because the share prices trade lower.
What are the fees involved
When you consider your investments, consider the cost involved too. Typically your bank investments do not have monthly fees, but some banks may offer a higher interest rate but would then charge you a monthly fee.
When you consider investing in unit trusts or the equity market, when using a stock broker, the fees are generally based on a percentage of the funds you invest. Most online platforms use a stock broking licence to invest on your instruction, so even though the stock broker is not directly involved in the decision of your investment, they will still be involved in executing the transaction. For this they will charge you a fee.
Generally if you use a financial advisor to invest funds for you they would also charge a fee to do this. The question you should ask yourself is not “why must I pay the fee”, but rather “what value can the financial advisor add to my portfolio”. For this reason it is always recommended that you consult with a CERTIFIED FINANCIAL PLANNER® professional as they are skilled experts that can guide you through the entire process
Tip: You can find a CERTIFIED FINANCAIL PLANNER® professional on Financial Planning Institute (FPI) website by visiting www.fpi.co.za.
In conclusion: The National Consumer protection act prohibits multiplication schemes offering you a rate of 20% more than the current repo rate. The current repo rate is 9%, so any investment offering you a return rate of more than 29% is in fact contravening the act. If you are unsure about the investment you are about to make, always consult with a CERTIFIED FINANCIAL PLANNER® professional.