Sun | Apr 23, 2017

Financial Adviser | The best way to invest

Published:Sunday | August 9, 2015 | 8:00 AM

QUESTION: I have some funds available. How is the best way to invest them?

- Horace

FINANCIAL ADVISER: I wish I could give you a direct answer. My answer is: It depends. It depends on your investment objectives, your risk tolerance, your time horizon, the rest of your portfolio, the resources you have to invest, your knowledge and understanding of investments, your place in the life cycle, and your goals.

Investment objectives include regular income, preservation of capital, growth or capital appreciation, ease of management, exchange rate hedge, liquidity or ease of converting to cash, diversification.

Your objective influences your choice of instrument and some instruments may satisfy more than one objective, but there is usually one that is best for a particular objective.

For regular income, bonds are best. The income earned from bonds is interest. Dividends from stock may pay regular income, but this is not guaranteed.

Bonds are also good for preservation of principal in the sense that you are likely to get back all the capital you invest. This is generally the case if you hold them to maturity. But if you sell before then and interest rates rise above the levels existing at the time you made the investment, you are almost certain to lose some of your capital but should gain if interest rates fall instead.

Unit trusts and mutual funds that invest in bonds and other interest-earning financial instruments are also good for preservation of capital. Some also distribute income, so they would be good for regular income.

If you want capital appreciation to hedge against inflation, stock and securities linked to real estate are suitable. Unit trusts and mutual funds that invest in these securities are also suitable. Some unit trusts and mutual funds also invest directly in real estate.

If your risk tolerance is low, that is, you do not have the capacity to tolerate fluctuations in the value of your investments, bonds are best for you. You would hardly be comfortable with investing in stocks and perhaps real estate and associated instruments. On the other hand, you would be comfortable with them if your risk tolerance is medium to high.

Ease of management refers to maintaining a portfolio of investments without having to manage them on a day-to-day basis. Unit trusts and mutual funds are very suitable for this purpose. This function is undertaken by professional fund managers. They make the buying and selling decisions and attend to other matters related to the management of the portfolio.

If you want protection against the local currency losing its value, invest in instruments with a foreign currency-earning component, which span virtually all instruments in the marketplace.

Liquidity refers to the ability of an instrument to be converted to cash easily, that this, the conversion to cash can be accomplished in a relatively short time at or close to its value. Bonds generally fit this objective quite well.

If you want a diversified portfolio, you may invest in several types of securities. The easiest way to accomplish this, though, is to invest in unit trusts or mutual funds. And there are many types of these instruments to meet every objective you may have.

Time horizon refers to whether you will require the funds in the short, medium or long term. Nowadays, the time line associated with these is much shorter than I was used to in the past but I am prepared to accept short term as up to two or three years, medium term, over that and up to ten years and long term anything above ten years.

Bonds fit all the above. It is their maturity date which matters. Unit trusts and mutual funds can be converted to cash quite easily but it is advisable to treat them as long term investments. Stock may yield good yields in the short term but it is best to treat it as long term.

If you already have an investment portfolio, it is important to see how new investments would fit into it. The experts will tell you that asset allocation has a stronger bearing on the performance of your portfolio than securities selection. The selection you make should not disturb your asset allocation or the proportion of your portfolio in the various types of investment instruments.

If the resources you have to invest are small, it is advisable to invest in unit trusts or mutual funds because the minimum sum accepted for investment tends to be less than for other types of instruments.

Additionally, if you have limited funds, it is advisable to avoid more risky investments. Persons with more resources are better able to withstand losses.

Your age will have some bearing on your decision. The younger you are the more time you have to recover from your losses but the smaller the pool of funds you will likely have and the less you are likely to know about investments so your risk tolerance may be low. At the other end, the nearer you are to retirement, the less risk you can afford to take.

If your knowledge of investments is limited, it is prudent to avoid the more complicated instruments such as structured notes.

Importantly, what is your goal? This will have some bearing on your time horizon, investment objectives and your strategy.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel.