Investment Options - IEB Grade 12 Business Notes PDF

# Investment Options ## Equities/Shares - Equities are also known as shares in a company. Some companies are listed on the JSE Ltd but other companies are unlisted. The owners of shares (equities) each own a portion of the business. - There are two "options/methods" to become a shareholder in a c...

# Investment Options ## Equities/Shares - Equities are also known as shares in a company. Some companies are listed on the JSE Ltd but other companies are unlisted. The owners of shares (equities) each own a portion of the business. - There are two "options/methods" to become a shareholder in a company listed on the JSE: - The shares were bought from the company when shares were issued the first time, thus the person who bought the shares contributes capital to the business. - The shares were bought on the JSE from a previous shareholder. The money paid for the share is not going to the business, but to the person who sold his/her shares. Shares bought and sold on the JSE have no impact on the capital available to the business. - The JSE (and other stock exchanges in the world) have strict rules for companies to list on the stock exchange to protect investors and (hopefully) decrease the risk of investing in these listed companies. - Despite this, equities are still seen as a moderate to high risk investment. - Blue-chip shares are shares in high-end companies on the stock exchange and the risk of acquiring shares in a blue-chip company is smaller than having shares in another company. The ROI in these blue-chip companies is usually higher than in other companies. ### Risk - Shareholders will buy shares in the company with the expectation that: - The share price will increase over a period of time (capital growth) - Good dividends will be generated. Dividends are the profits of the company that are divided among the shareholders, and are not taxed in the hands of the shareholder in South Africa. What will determine the price of a share on the stock market? The answer to this question is quite simply: market forces, or otherwise known as demand and supply! - The following factors will all impact on the demand for the share and therefor also the share price. This means it will also have an impact on the overall return on the shareholders' investment (ROI): - The level of confidence in the state of the economy. When the economy is doing well, investors will feel positive about investing on the JSE and they will be eager to buy shares (bull market). If investors are pessimistic and they anticipate losses, they will sell their shares (bear market). - Government policies or *new legislation* will impact on the overall confidence in the economy of the country and therefore the share prices. If, for example, there is speculation about nationalisation (state takes over ownership of private assets), shareholders will want to sell their shares and the share prices will drop. - Industry performance will affect all the companies listed in that industry. Some industries may be more attractive to investors than others. - Financial performance of the business: sales, profits, financial ratios such as solvency, liquidity, return on employment, and the *dividends* declared. The better the financial performance of the business, the more likely the company is to declare good dividends and as a result the share price is likely to increase. - Management and the public's confidence in the management team. The higher the confidence in the management team, the higher the demand will be for the shares and share prices will increase. - Social issues surrounding the company may, for example, include its image in terms of environmentally-friendly manufacturing processes or the degree of involvement in CSR. This may either have a positive or negative impact on share prices. - Legal issues such as pending law suits or allegations of price fixing may have a negative impact on the share price. - Media coverage increases public awareness of the above developments, thereby creating certain perceptions of the country, industry and/or company with investors and potential investors; this in turn it will have a direct impact on share prices. ### Time frame - Some people prefer to invest their money in shares with no short-term need to see huge capital gains. - The investor will invest in blue-chip shares where there is capital growth (increase in share price) in the long term, and where dividends earned from the share portfolio are often used to buy more blue-chip shares. - People that speculate with shares approach the matter differently. Speculators buy shares in companies that (in their opinion) will have a quick and significant increase in the share price. The speculator will then sell the shares when there is an opportunity to make a profit based on a higher share price. The speculator is not really concerned with dividends. ## Debentures - Debentures are also sometimes called bonds (not to be confused with a mortgage bond, which is a loan to buy fixed property). - A debenture is a letter of credit (an "IOU") that a business sells in order to raise borrowed capital for large projects. - Debentures are usually not secured by specific assets. - So if the company cannot repay the debt (debenture) and it is liquidated, the debenture holders will not have a preferential claim to assets. Having said this, people will be hesitant to buy debentures in companies that are perceived to be at a high risk of liquidation. - The debenture holder will receive interest on the amount of the debenture. - If the business issuing the debenture is perceived to be a high risk, a higher interest rate will have to be offered to convince people to buy the debentures. - Debenture holders can sell the debenture at any stage to other interested parties on the JSE. ### Types of debentures - A redeemable debenture is repayable on a predetermined date. - An irredeemable debenture is never paid back by the company, but will last indefinitely with the debenture holder getting interest. - A convertible debenture will be converted into shares at a predetermined date in future. ### Risk - When the debenture is sold, it is often sold at a fixed interest rate, which has benefits and risks. - Because debentures are usually *unsecured* financial instruments, there are always risks of the business going bankrupt, with a consequent loss for the debenture holder of his/her investment. - The degree of this risk will be determined by the company's financial strength; and of course, the degree of risk linked to the projects / type of activity with which the business is involved. - It carries a higher risk than investments at banks, but a lower risk than an investment in shares, because creditors rank higher than owners to recoup their money in the event of liquidation. ### ROI - The company that issues the debenture is legally obliged to pay interest. This increases the potential for a return on investment when compared to shareholders, because the company does not have to declare dividends if the financial position does not allow it. - There is no capital growth associated with debentures, just a steady stream of interest. - Because debentures are *unsecured* debt, the business has to offer a higher interest rate to potential investors to compensate them for the higher risks. - Remember interest income is taxable (above the threshold) and after tax is paid, the ROI on debentures seldom beats inflation. ### Time frame - Long-term financial instrument to earn interest until such time as the debenture is redeemed. ## Retirement Annuities & Pension Funds - A retirement annuity (RA) is a policy that aims to provide an income to the person when he/she reaches the age of 55. - A monthly premium is paid and when the RA pays out, it will be in a lump sum, combined with a monthly income. The amount of money paid out when the RA matures, will depend on the period the premiums were paid and/or how high the premiums were. - The government cannot provide for all citizens to maintain a decent standard of living on old age pensions, thus it wants to encourage people to make provision for their own retirement. For this reason tax relief is given on RA premiums. - Pension funds are created when all employees, belonging to the particular pension fund, pool their contributions with a Pension fund administrator. - This administrator then invests the funds in such a manner that it will (hopefully) grow and exceed inflation. When people reach retirement, they then receive a monthly pension (income) from the fund. - Contributions made to *pension funds* are deducted from salaries before taxable income is calculated. The reason, once again, is that government wants to encourage people to make provision for their own retirement income. ### Risk - The risk associated with both a RA and a *pension fund* will depend on how and where the administrators have invested the contributions of members. - Both RAs and Pension funds are tools to make provision for an income when the employee stops working and goes on pension. - People wait too long before starting to make provision for retirement - People generally live longer due to good medical care and, therefore, need to make provision for a longer time after 65 (retirement age), when they will be without a salary. - Getting older may also mean more money is needed for health care. Additional. provision should be made for these costs. - People do not always consider the loss of benefits when they retire. - When people change jobs, the *pension* built up at the previous job may be paid out. - People should immediately reinvest this money in the new pension fund, rather than spending it on luxuries. Unfortunately, many do not reinvest their money. ### ROI - The ROI will be determined by the prudent decisions of the investment manager that handled and invested the contributions. - There are no guarantees and even if a specific ROI is guaranteed by the RA fund/Pension fund, it is important to compare this to inflation. - Also be aware that most financial instruments (pension funds and RA included) will have administrative costs and management fees which will reduce the ROI. ### Time frame - Provision for retirement, be it in the form of a RA or a *pension plan* is something that should be started as soon as possible and maintained for the entire 40 or 45 years that a salary will be earned as an employee. ## Endowments - Endowments are a form of *long-term* saving. - The saving can be in the form of lump sum investment and/or monthly contributions. - The investor will get the full amount after a predetermined period when the policy matures (usually 5 to 10 years), or in the case of death, the next of kin will receive the investment immediately. ### Risk - When taking out an endowment policy, the investor can choose the risk profile he would like to have - varying from high risk in an equity fund to a *lower* risk where a more balanced investment approach is followed. - If the investor has chosen to invest *monthly* contributions, it is possible (with some insurers) to add a Contribution Waiver, which means if the investor suffers from a serious illness or becomes disabled, consequently being unable to continue contributing to the investment, the insurer will pay the *monthly* contributions on behalf of the insured. - This is a form of risk management that the insured can take out in the event of adverse circumstances. ### ROI - The ROI will depend on the risk profile chosen. - There are management and admin fees that are deducted from the savings amount that will reduce the ROI. ### Time frame - Period of between 5 and 10 years. It is thus a *long-term* savings plan. ## Offshore Investments - The same choices have to be made when investing in a different country (offshore). ### Risk - Diversification (when referring to offshore investments) means that risks are spread over different countries. - Some countries are considered to have more stable markets (developed countries) than others (emerging markets). ### ROI - Changes in exchange rates may make it more attractive to invest in another country. - There may be investment opportunities in other countries that do not exist in South Africa. - South Africa does not have oil and if an investor feels oil is a good investment to make, he/she will have to *buy shares* in an oil company listed in another country. - Someone may consider the option of emigration to a different country. - Because of *the* exchange control mechanisms in place in South Africa, it is only possible to take a limited amount of money out of the country each year. - It may then be a good idea to begin to an investment portfolio in the foreign country. ### Time frame - The only limitation in terms of time is the amount of money that may be taken out of the country every year owing to exchange control by the Government. - Offshore Investments, however, may be used as a long-term or short-term investment strategy. ## Unit trusts - Unit trusts can be described as a "basket of shares" that is trading on the stock exchange. - When buying Unit trusts, the investor will indicate the type of risk profile that is acceptable to him/her. - Unit trusts are managed by a fund manager that is responsible for looking after that specific fund. - A Unit trust fund can be diversified over various industries on the JSE or between various companies within a particular industry. The person buying the unit trusts decides which option he/she wants to invest in. - Unit trusts can be bought with a lump sum, monthly contributions or a combination of the two. ### Risk - The options available to choose from may vary - From a high-risk Equity fund where all funds are invested in shares, to a Stable fund where risks are reduced by diversifying investments between equities, international markets and even investing in some low risk money market instruments. ### ROI - A good Unit trust investment will outperform inflation over the medium term of 3 to 5 years. ### Time frame - Investing in Unit trusts is usually a *medium to long-term investment*. ## Collectibles - Examples of collectables may include antiques, coins, artwork, stamps, jewellery and Kruger Rands. ### Risk - The market for collectables in South Africa is limited when compared to the rest of the world, but with technology this is becoming less of a problem. - To deal in collectables requires a *high level* of knowledge and expertise. ### ROI - If the article is truly a collectable, the value of the article will increase over time (provided there is no damage). ### Time frame - The markets for true collectables are not really volatile and this type of *investment* generally shows growth over a *long* period. ## Notice Deposits ### Fixed Deposits - A fixed deposit is opened with the bank when a fixed amount of money is invested for a fixed (predetermined) time at an interest rate that can either be fixed or changes as the prime rate changes. - Fixed deposits are long-term investments and the money may only be withdrawn when the maturity date is reached or when the investor dies. If the investor wants to withdraw the funds before the maturity date, a penalty will be charged. ### Risk - Money invested with the bank generally has a very low risk. - The investment can only be "lost" if the bank is liquidated. - It has happened in South Africa that banks have been liquidated in the past, a relatively rare event. - However, take note of the situation where African Bank was placed under Curatorship in Augustus 2014 to understand that even money in the bank, carries some risk. ### ROI - The interest rate offered on a fixed deposit will differ from bank to bank. It will also depend on the amount of money invested. - Generally the longer the time frame and the higher the amount invested, the higher the interest rate will be. - The only capital growth achieved with a fixed deposit is, if interest on the fixed deposit is capitalised (re-invested). - Cumulative interest is then earned on the original fixed deposit and the interest that was reinvested. ### Time frame - Fixed deposits can be from a year to 10 years (or even longer). - The longer the time frame of the investment, the higher the interest rate usually is. ## Money Market Accounts - A Money market account is a form of short-term investment and it is becoming increasingly popular. - It is easy to gain access to money market accounts in the short-term, because they are very liquid. An example of a money market account is a *call account*, where money is invested "indefinitely". - The investor only has to give notice that he/she wants to withdraw funds in the future. A 32-day call account has a notice period of 32 days. ### Risk - Money market *accounts* have a low risk, but offer a lower interest rate than *longer-term investments*. ### ROI - The interest rate on money market *accounts* usually outperforms normal savings accounts. - This makes them attractive options for short-term investors. ### Time frame - A money market account is a *short-term investment* option, ranging in time periods of about a month to a year. ## Real Estate - Real estate investing involves the purchase, ownership, *management*, rental and/or sale of real estate for profit. ### Risk - The risk in real estate is *usually* low, as long as the property is in a good neighbourhood. The investment will increase over time. ### ROI - If the person is staying in the home there will be no return, until the house is sold. But if it is a second property, the property could be rented out and income earned. - Home prices *usually* increase over time, so if the property is later sold, there should be a profit. - Of course there is the issue of capital gains tax if it is a second property. (i.e. if it is not the house in which the owner lived). ### Time frame - Property is a *long term* investment. - The value of property *usually* does not increase overnight, unless it was a house which has been neglected and then renovated and sold it for a profit. - In this case we would say the person was speculating with property.