Financial Times

Prudent ways of investing money

By B.L. Ariyatillake
"Money that is nowhere must be somewhere" … so goes the saying. As we all know there is money in circulation in the country's economy. Where do we find this money? Is it in the people's hands? People hold money in their hands for two good reasons - namely for their day-to-day consumption needs or sometimes as a precautionary measure for sudden expenses. In addition there are fortunate people who have a surplus. What do they do with that surplus? If they keep that money in cash they get no income and inflation will eat up this surplus money. They go for investments bringing them income mostly in the form of interest.

Choosing an investment is a difficult one and it should be done in a prudent way. The most important factor is that the investment should cater to the needs of the investor and should suit him or her. He must be clear in his investment objective. For example, one may prefer high current income; or liquidity; or want protection from inflation and taxes or consider long-growth and so on.

The basic principle in investment is the placing of a capital sum in order to obtain an annual return thereon in the form of net income. The investor exchanges his capital sum to a future flow of income to him.

In a modern day economy there are various investments. For example, Savings Accounts, Fixed Deposits, Treasury Bills, Stocks and Shares, Unit Trusts, properties and many more.

At any given time there is a certain amount of investment money available in the economy for investments. Each of the above investment outlets competes with each other to attract the available money in the investment market. The sub-divisions in each category compete with each other to get the money into their hands.

An investor should be concerned only in the net income he is able to derive from the investment. He is not bothered with the gross income. For example if you invest in a residential property your income is in the form of rent, which is a gross income. The investor will be bound to spend out of this gross income certain outgoing such as maintenance costs, rates and repair payments, costs of letting, insurance, etc. which have to be deducted from gross income to arrive at his net income.

Many years ago people used to hoard money -- that is they kept their money in cash at home or other safety places. As people became aware of investment opportunities they started depositing surplus money in Savings Accounts beginning with the popular Post Office Savings Bank of yesteryear. Today savings are highly institutionalised.

With the recent collapse of a bank, people are disturbed and are now in search of safe investments. They all blame the Central Bank for this catastrophe. The Central Bank may have had a say in this. But the primary cause is that these depositors have not been prudent and gone after higher returns. Income return is not the sole criterion of a good investment. The investment should meet the needs of the investor. For example one may want his investment to be highly secure or one may want high liquidity and so on. Certain people may go for the highest return irrespective of other criteria. Security of the money invested is very important. This is why many small time investors prefer the state-owned National Savings Bank (NSB).
Institutions like this could attract investment at low rates. The principle is -- higher the security, lower the return. People are satisfied with this return because they know their money is in safe hands.

If other financial institutions want to compete with the NSB to attract investment money they have to pay higher interest rates because people consider the NSB with government backing a safer haven for their money.

State banks rank next to the NSB in terms of security with private banks and private financial institutions following.

Security of the investment is important. Equally important is the security of the income from the investment. If the invested money is safe, income is also sure and safe. But there are investments such as property where income cannot be depended upon.

The next test an investor should look into is liquidity of the investment. By liquidity we mean how soon your invested money could be converted into liquid cash. Next in rank is money in savings accounts, for such money could be withdrawn almost immediately over the counter. The principle is -- higher the liquidity, lower is the rate of interest.

A fixed deposit is the placing of a capital sum for a specific period in the hands of a financial institute. The specific period may vary say from three months to even up to about six years. The money one has placed in a fixed deposit cannot be withdrawn until the expiry of the period of the deposit. Of course payment of interest could be arranged monthly, quarterly, bi-annually or at maturity.

The next factor is management of the investment. For example investments in savings accounts, fixed deposits, stocks and shares have minimal management whereas investments in property entail high management. This is why pensioners and older people prefer to invest their monies in investments that have no management. They cannot bother about management.

Capital appreciation or depreciation of the investment is very important. For example, there is no capital appreciation or depreciation in savings accounts or fixed deposits. You enjoy the interest regularly but the invested capital sum remains the same with inflation eating into the capital sum.

Investment in quoted shares of companies can bring in capital appreciation or depreciation. Dividends are paid but the market value of the share can go up or down. If it goes up the investor is lucky for when he converts his investment to liquid cash by selling the shares, he gets a sum in excess of what he invested. If the share prices go down, the investor stands to lose. If one is not conversant with the share market he should not attempt to invest in shares. Unit Trusts are better for such persons, because the professional expertise could be obtained directly by the investor.

Property is an investment of high security. The disadvantages are low liquidity and high management. But the plus factor is capital appreciation. During the past two decades property values have escalated to enormous levels bringing unthinkable capital appreciation to investors. Even if one has bought a bare block of land and kept it idle over the years, capital appreciation outweighed the interest he would have got had he invested in a savings account or fixed deposit.

For this reason property is considered a hedge against inflation. Inflation affects all investments but the capital appreciation in property conquers the inflation.

Property had been the foundation of many successful men throughout the world. But no one should invest in property if he cannot manage it or wants high liquidity of investment. Risk always brings in better returns. One cannot have high returns if he is not prepared to risk his money.

Everyone should attempt prudent investments. Risky investment is for those who couldn't afford to take risks.

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