There is a great interest on the financial markets especially by young people out to make an additional buck from their savings. In fact, any young person not speaking about business is talking about investments. After my previous post comparing investment in the money markets against saving in banks and several inquiries via inbox, I found it good to expound on this concept.
Financial markets are a segment where capital is principally traded. I works t bring together buyers and sellers who trade in financial assets e.g. stocks, bonds, derivatives, currencies etc. It therefore acts as a match maker between those who have capital with those who lack or have a deficit.
Financial markets exist in two classes, depending on activity: capital markets and the money markets.
Capital markets comprise of activities in which instruments are traded for a long period or long term investments for a characteristic period of more than a year. The most popular of these are stocks (shares) or bonds (corporate or government). Institutions use this segment of the markets o raise capital for long term or capital intensive projects e.g. organization reorganization, expansion, etc. in this case, investors buy the instruments (stocks or bonds) and trade them, for a period of time. The financial instruments are traded exclusively through an exchange. In Kenya, the Nairobi Stock Exchange deals with this exclusively. The capital market trading translates to equity. This is compensated to the investor as dividends over time.
One characteristic with this segment is that capital markets are considered risky especially for short term investments and hence not good for short term ventures. And example are the IPOs in which investors buy into the ownership of a corporate and sell it after some time. IPOs offer an exciting opportunity especially with the current government efforts to offload share holding in its corporate institutions.
In the short run, due to volatility and market dynamics, inflation may erode the purchasing power of funds. For instance, in 2006, KenGen issued an IPO with a share price of Kes. 15.15. The current price, six years later, averaged Kes. 5.17 as on 18th December 2016.
However, it must be noted that the high risk over time corresponds to high returns. Eight years after Safaricom was privatized has seen the share price grow by a whopping 376% in value to trade at Kes. 83 as at 16th December 2016. It therefore suits best those investors who intend to grow wealth over the long term like to cater for retirement, education, etc. it is appropriate for young risk takers for that matter.
The other segment of the financial markets is the money markets. In his, short term borrowing is done over short periods of time, usually less than a year. The liquidity is high, hence money is easily available and conveniently. They are therefore very convenient for mobilsing funds or capital to undertake a project in the short term. They offer a safe haven for funds over the short term and hence a favourite for low risk investors. Since the risk of investment is low, the comparative returns are also low. His option is relied much upon by fixed income earners since the cash is readily available when needed. It therefore means when a company borrows using this, the investment translates to a debt by the buyer (capital seeking entity) which they have to pay compensation for in form of interest over time. The trading of these instruments is not done formerly, but informally through what is referred to as Over the Counter (OTC) trading.
One thing noteworthy is money markets can also be accessed alongside the capital markets and hence, cannot be considered to be exclusively dealt with singly or in exclusion.
The money market is a favourite among many investors who target this segment due to its flexibility and the steady high returns compared to bank savings accounts. However, it should be noted that the funds held in money market accounts are not insured. Other concerns raised include the opportunity cost of holding the funds in these funds vis a vis the market factors such as inflation, which may erode the purchasing power of the funds over time. The administration charges of these funds may also eat into the resultant yield of the funds hence reducing the overall net gain over the investment period.
It must be noted that there is a difference between money markets and money market mutual funds. Money Market Mutual funds are a collection of investors funds, which are invested together to minimize risk of exposure to credit and market/liquidity associated risks. Investors funds are thus pooled together and invested in a variety of portfolios and the returns paid proportionately over a period of time. They are low risk, flexible and easy to operate. In addition, they form a huge portion of the retail money market fund segment that allows individual small scale investors to access investment opportunities.
The most favourite mode of investing in this segment is through unit trust funds. Most of the small scale investors like start ups and students employ this mode of creating wealth over the short term. They therefore provide a very convenient way to mobilise funds ventures. Do you intend to grow your capital reserves over a short period of time in order to start a business? This is the most appropriate way to achieve this goal. The main advantage of using unit trust is the professional investment portfolio management that the companies provide alongside diversification of portfolio risk which lowers the risk level. You need not indulge yourself in the business of managing the risk but just open an account, deposit funds and the returns are deposited back into your account. They enable the investors take advantage of economies of scale since they have a higher bargaining power and hence, returns. The accumulated funds are thereby invested through instruments like treasury bills, certificate of deposits and commercial papers which are professionally managed.
So what should you consider when investing in the money markets?
The fist consideration should be the yield in terms of compensation to the investor over time. The higher the yield, the more attractive an option should be. It has been found that capital markets offer a higher yield compared to savings accounts in banks. I have captioned an extract of 15th December 2016 of various Unite Trusts and Balanced Fund yield rated for savers review.
The amount of interest to be earned cannot be used in exclusivity. Several other factors should be put into play to make a good choice on which fund to invest in. A second factor to consider is the minimal deposit requirements. Some money market players require a minimal amount of cash to be used as initial deposit for the account to be opened, which might be discouraging for small scale investors. Some may also require that a minimal balance be maintained in the account over time.
Liquidity is also a major factor for consideration. This is how fast one can access funds from the investor funds held. Some may be restrictive, requiring a long period of time and others are short. The longer the period, the more liquid the option is.
Some entities have administration fees or commissions which they charge to manage the portfolio. As a demerit, this can really be punitive to efforts to grow wealth since, over time, these charges can erode the volume of compensation an investor may earn from the fund. Inasmuch as a fund may have higher yields, the erosion of the value of the net returns by associated charges should be taken into consideration.
Another very essential thing to consider is the size of the fund. Larger funds help to minimize risk exposure to the investor by taking advantage to the economies of scale and diversification of portfolio. Hence, the larger the fund, the lesser the impact of a singles investor actions are. Small sized funds are really affected by for example, the withdrawal of a single investor due to the economies of scale associated with such a move. This is the reason why investment funds would always seek to grow their portfolio to absorb such shocks.
The reputation of the investment fund should also be looked into. What do customers say about the company? How are their reviews online? It would be important at this point, for example, review their page reviews on social media sites for example. Some funds are known for encouraging investors to deposit funds with them but become a menace when the times come for withdrawing. How do they treat their customers?
The beauty about investing in the money markets these days is most of the activities have gone paperless and online. With a few clicks and a minimal deposit which is easily available, one is able to start off on his journey to prudent wealth management and creation! The issue of lack of capital to start businesses or fund other short term projects should not arise. The power is in your hands.
Wishing you a fruitful savers trip, folks!