Investment Options

What are the various avenues for investment?
There are so many avenues to choose from in the modern financial system. Some of these offer attractive returns but with high risks and some offer lower returns with low risks. Some of the investment avenues include:

a) Equity Stocks
These represent ownership in the particular company and offer a relatively high potential for capital appreciation, relative to most traditional investment avenues. Equity investing is normally considered to be an excellent route to generating higher real returns over the long term approximately ranging from 15-50% annually.

However, the risks associated with this investment route for example volatility of returns, capital preservation over the shorter term are higher.

b) Mutual funds
A type of investment where a number of investors’ money is pooled together and used by the fund manager to invest in underlying securities in line with the objectives of the scheme.

The fund’s assets are owned by investors in the same proportion as their contributions bears to the total contribution of all investors put together and hence, the gains and losses are also
shared in the same proportion. They offer moderate returns of about 12-30% annually and are less risky in comparison to equity stocks.

c) Bonds
They can either be government bonds or company bonds. Bonds have very little risk of loss of funds invested and therefore offer lower returns.

Company bonds are however more risky than government bonds, as a company may fail to honor the obligation to buy the bonds on maturity, which is not possible for government.

d) Commodities
As an investment in products like agricultural produce such as rice and wheat, metals, minerals etc. This is a very tricky investment similar to the equity asset class as one should be able
to understand the weather, crop cycle and market dynamics.

Hence the risks associated with this investment route in terms of volatility of returns and capital preservation are higher.

As an investment in products like agricultural produce such as rice and wheat, metals, minerals etc. This is a very tricky investment similar to the equity asset class as one should be able
to understand the weather, crop cycle and market dynamics. Hence the risks associated with this investment route in terms of volatility of returns and capital preservation are higher.

e) Bullions
Bullions are also part of commodities. They include investment in gold, silver and platinum. They fetch high returns but are also very volatile.

f) Real estate or property investment
Real estate investment refers to acquiring exposure to real estate properties either directly or indirectly with the expectation of earning returns, either via price appreciation or rental income.
It offers attractive returns but the price fluctuation in bad times is very high and it requires a lot of income to get started.

g) Insurance
A form of management of risk where one party transfers risk to another. Usually, a company or a person may transfer the risk to an insurance company that undertakes to suffer the cost of the
loss in case of unforeseen event leading to loss of revenue. In return, the company pays or individual pays and agreed monthly or annual fees in form of insurance premiums to the insurance company. You must ensure that you are dealing with insurance companies duly licensed by the Insurance Regulatory Authority of Uganda.

h) Provident funds
Is one of the safest long term investment options. This is mainly for retirement purpose.

I) Treasury Bills
These are securities regularly sold or auctioned by Bank of Uganda on behalf of Government. Private investors can buy these directly or through their Banks.

How does one choose an investment option?
Investments reap high returns only if done wisely. The choice among the various options depends on your age, personal circumstances, financial commitments, liquidity needs and risk appetite.

  1. A persons’ age along with his or her personal requirements is a key factor to be considered while making an investment decision. If one is still young and is looking for a long term investment, he can invest in equity or start a business.
  2. On the other hand, if he is nearing retirement and prefers capital preservation, investments in debt mutual funds, bank deposits or fixed maturity plans are ideal
  3. Liquidity is also a factor in choosing an investment option. It refers to the ability of a security to be bought or sold without a significant negative impact on the price. Gold is normally easy to liquidate, while real estate assets on the other hand have low liquidity.

Risk appetite refers to the level of risk that an organization is prepared to accept, before action is deemed necessary to reduce it. It represents a balance between the potential benefits of innovation and the threats that change inevitably brings.

Returns expected play a key important role in choosing an investment. They are normally directly commensurate to inherent risks of the instrument. Thus, equity is associated with a higher return potential, while debt instruments are preferred avenues for capital protection and regular income, rather than capital appreciation.

It is therefore important that a person understands the asset classes and risks in reviewing the investment options considering his objectives and strategies and then decides on a choice suitable for his satisfaction. There is basically no best way that will suit everyone’s’ investment needs. Consideration for one’s attitude towards risk and their investment horizon is important.

What kinds of risks are involved in investment?
Every investment has risk and dealing with risk is a normal part of investing which if not managed properly can hurt the investment. The types of risk that usually affect investments include:

a) Interest rate Risk

The risk that interest rates will go up after you’ve locked your money into a fixed-rate investment meaning you don’t earn as much on your money as you would if you had invested at a higher rate.

b) Inflation Risk

The risk that the rate of return on your investment over time will not be high enough to offset the effect of inflation, which erodes the buying power of your savings.
Inflation risk could result from investing too conservatively, while market risk increases with more aggressive investments. In short the investment does not earn enough to keep up with inflation.

c) Liquidity Risk

The risk that you won’t be able to sell your investments quickly for the price you want or the possibility of buyers interested in your investment not being there when you want to sell.

d) Business Risk

The risk that the company or industry you’ve invested in won’t do well.

e) Credit Risk

The risk that a borrower won’t be able to repay his debt and you may lose your money.

f) Exchange-rate Risk

The risk that when you change your money back from foreign currency to a domestic currency, the exchange rate may have changed to your disadvantage.

g) Political Risk

The risk that a political event in the country you’re invested in will negatively affect your investment.

Is it necessary to first seek professional advice when looking to select an investment option?
Whereas it is possible to undertake an investment by oneself, it usually involves a fairly large amount of time, sufficient knowledge about research and significant effort as one has to evaluate the many investment options available and select the most appropriate option, suited to his or her risk profile and return requirements.

Relationship investment managers are well trained and accredited professionals who follow a personalized and formal approach to serve investors financial planning needs. With their help, one can avail of a full range of financial services like wealth management, retirement planning, insurance etc.

Although not mandatory, it is recommended to obtain investment advice of a professional.

What various approaches can be followed in investment?
An investment approach should ideally depend on the investor’s investment time horizon, risk appetite and return expectations. These in turn, are determined by the personal circumstances and other factors like age, standard of living and other future financial commitments.

Broadly, however, there are three basic approaches to investing:

  1. Conservative approach: Where focus is on preservation of capital. This can be achieved by investing in low risk securities, at the cost of earning relatively low return potential.
  2. Moderate approach: This approach is followed by investors who are willing to accept a moderately higher level of risk, to earn higher returns as compared to a conservative investor. This strategy primarily focuses on achieving higher risk adjusted returns.
  3. Aggressive approach: This approach accords the highest priority to earning returns, even as the risk undertaken to generate these returns may be commensurately higher.

Is it possible to change investment allocations and how frequently can it be done?
It is part of responsible investment practice that an investor should regularly review his or her investment objectives and strategies in regard to investment allocations in order to ensure that all possible opportunities are fully optimised.

As such, changes are necessary from time to time. How frequently this occurs depends on the investors risk and return profile in regard to the investment option or options available.

Through which ways can an investment be diversified?
Diversification means investing in a wide variety of asset classes, security types and industries in order to reduce risk exposure while striving for substantial rewards. The general idea is that you want your investments to be different enough so that when one is doing poorly, another might be doing well.

As the saying goes, “don’t put all your ages in one basket.” If all your eggs [investments] are in one basket [investment option/ company or stock] and it falls (collapses) you will lose all the eggs in that basket (you will lose all your money invested.)

Diversification also does more than just reduce risk. An intelligently diversified portfolio will nearly always outperform a single investment.

Ways through which investments can be diversified include:

  1. Investing in more than one asset type. For example, include stock, bond and cash investments in your portfolio.
  2. Buying different varieties of the same security type. For instance, rather than buying just large-cap stocks, buy some small-cap stocks too.
  3. Investing in different industries.
  4. Investing in mutual funds and diversifying among different types of mutual funds.

How is investing in securities or asset classes any different from having money in the bank?
Money in the bank is usually stable but this stability comes at a cost as it typically may not earn enough to meet an investors long-term goals.

Records show that investing in securities and some asset classes earn the investor a higher rate of return in the long run than cash in the bank that earns fixed interest.

However subject to the investor’s individual character it is sensible to have a diversified investment option such as shares, property, cash and commodities.

Is it possible to have negative returns on an investment?
Despite diversification, it is still possible to have negative returns on an investment. Usually different asset classes will react differently to influences such as economic growth, inflation, interest rates and exchange rate movements implying that when one asset class performs poorly, another may be performing well.

To put this into perspective, shares may fall within a one year period due to fluctuations in the market hence earning negative returns. However markets by their nature tend to recover which later on earn shares a higher rate of return than any other asset class such as cash.

It is however impossible to know how long any market conditions will go for so there in need for an investor to have a financial strategy, keeping in mind that just because an investment option falls now, it does not necessarily mean that his investment will lose money.

How can an investor assess the performance of an investment option?
An investor has to consider several different ways of measuring performance. The measures he chooses will depend on the exact information he is looking for and the types of investments he owns. If the investor is conservative, he may be primarily interested in the income the investment is providing.

He may want to examine the interest rate in relation to current market rates. Of course, if market rates are down, he might even be tempted to buy investments with a lower rating in expectation of getting a potentially higher return.

Some of these performance measures include:

a) Yield

Is a measure of the income an investment pays during a specific period, typically a year, divided by the investment’s price. It is typically expressed as a percentage. All bonds have yields, as do dividend-paying stocks, most mutual funds, and bank accounts including certificates of deposit (CDs).

b) Return

Investment return is all of the money an investor makes or loses on an investment. To find total return, generally considered the most accurate measure of return, you add the change in value up or down from the time of purchase of the investment to all of the income collected from that investment in interest or dividends. To find percent return, you divide the change in value plus income by the amount you invested

c) Capital Gains and Losses

Investments are also known as capital assets. If one makes money by selling one of his capital assets for a higher price than he paid to buy it, then he has a capital gain. In contrast, if one loses money on the sale, he has made a capital loss. Capital gains and losses may be a major factor in measuring investment portfolio performance, especially if one is an active investor who buys and sells frequently.

e) Using index benchmarks

Generally, when people refer to the stock market’s performance, they’re actually referring to the performance of an index or average that tracks representative stocks or bonds. The index serves as an indicator of the overall direction of the market as a whole, or of particular market segments.
Investors use these indexes and averages as benchmarks, to see how particular investments or combinations of investments measure up.

f) Using Research

Another way to evaluate an investments’ ongoing performance is through analyst research. Analysts at brokerage firms and at independent research firms look not only at current performance, but also at future potential to give an investor a picture of an investment’s strengths and weaknesses in the context of the wider market. Analysts also recommend actions based on performance. The actual language analysts use may vary, but in general, they recommend that you buy, hold, or sell an investment.