IN this fast-paced and sometimes daunting global and local economic climate, new investors can sometimes feel paralysed by the plethora of investment options. Moreover, given that some investment options require detailed explanation, new and young investors often shy away from what they do not understand, and in many cases lose the opportunity to create wealth on investments that have reasonable or moderate risk.
When you are dealing with investments in any asset class, it is important that you first identify your risk appetite. That will be your first guide as to what types of assets will best suit you, while allowing you to have a comfortable sleep at night. Using three basic asset classes as an example, equities tend to have less risk than mutual funds, and both tend to have less risk than fixed-income securities.
The best way to mitigate risk is to look at the company's performance in key areas such as cash flow, profit, earnings per share and priceto- earnings ratio. This is a good habit to learn whether you are buying Apple or Salada Foods Jamaica stock.
   The best way to mitigate risk is to look at the company's performance in key areas such as cash flow, profit, earnings per share and priceto- earnings ratio. This is a good habit to learn whether you are buying Apple or Salada Foods Jamaica stock. #slideshowtoggler, #slideshowtoggler a, #slideshowtoggler img {filter:none !important;zoom:normal !important}  1/1  |
When we hear the term risk, it often conjures up negative connotations in the average person. In the investment world, however, risk is simply a necessary circumstance that must be present if a return on investment is to be made. Risk is therefore, in and of itself, neither negative nor positive on its own. Risk is necessary in any investment undertaking: the higher the risk, the higher the potential return, but the potential loss is also higher. Similarly, lower risk will tend to yield lower returns and the lower the potential loss as well.
Risk can therefore be good or bad, depending on the goal of the investment, as well as the outcome. Risk is thus inseparable from return. If you want a return of 15 per cent and more on your capital p.a., that is not a low-risk position, and cannot be achieved by keeping your money on government paper, Treasury Bills, BOJ CD's fixed income instruments. May I also add that any fixed income investment, particularly those overseas, cannot be considered low-risk if the return is in the region of 15 per cent. Check the credit rating, you are likely to see that any instrument yielding such a high rate also has having low credit ratings. If the credit was considered super safe, then the market would be willing to lend that entity money at single-digit interest rates.
The dilemma that is faced by the Jamaican investor is that of seeking to beat inflation, and exchange rate devaluation. The raw fact is that if you are not able to earn better returns than the inflation rate, and the percentage depreciation in the dollar, you are essentially earning a negative real return on your investment. Given that Jamaica's inflation rate has been approximately 8.9 per cent over the past three years and in the last 12 months alone the dollar has devalued by 10 per cent, we are almost forced to take higher than fixed income risk if we are to earn a real positive return on our investment dollar.
Let us look at three simple asset classes and their risk levels: Fixed Income, Equity and Mutual Funds. Fixed income investments carry lower risk, but risk nonetheless, as the recent debt restructurings have highlighted. No Investment is risk-free, but fixed income investments do carry lower risks.
Buying outright equities is on the other end of the risk spectrum, with much higher risk than fixed income. But here is where you have the potential to gain returns that can beat inflation and exchange rate devaluations, and thus give you a real return. An example of this is the returns made on the Junior Market Stock exchange by stocks such as LASCO Manufacturing and Access Financial Services Ltd. LASCO Manufacturing listed at $2.50 and is now trading at over $14.00 per share. Conversely there are some listings that haven't done as well.
The way to mitigate this risk is to simply do your due diligence. The best way to do this is to look at the company's performance in key areas such as cash flow, profit, earnings per share and PE ratio. You can find or derive these from an examination of the company's financial statements. This is a good habit to learn whether you are Buying Apple or Salada Foods Jamaica stock. The next thing is to examine the environment that the company is operating in. Difficult economic conditions can and have affected the performance of many companies.
Mutual funds carry higher risk than fixed income, but less risk than buying outright equities yourself. This is because the mutual fund manager tends to be an accomplished professional with years of experience managing funds, and picking investments. Mutual funds also pool funds from many investors, giving the fund manager the ability to purchase and sell assets on a larger scale than if he were just managing funds for a single individual. A mutual fund can also purchase smaller blocks of assets (both equity and fixed income depending on the type of fund) from a large number of companies across many different sectors, giving you much higher diversification, significantly reducing volatility and risk.
There are other ways that one can mitigate risk, through investment vehicles such as Call and Put options. However, these are for another article, as they represent additional complexity, and are generally used by more knowledgeable and savvy investors. The lesson here is to not be afraid of risk, but to be very diligent in your assessment of risk. Risk is your friend; it can allow you to experience real returns if assessed properly. If we fail to embrace risk, we may fail to embrace wealth creation.
Kevin Jones is an Assistant Manager of the Wealth Division at Stocks & Securities Limited and can be contacted via kjones@sslinvest.com