INVESTOR PROFILE
If you want to invest in any of the investment categories remember the importance of duration, risk, diversification, returns and liquidity. Before selecting any of the investment instruments, you should set your goals first and based on that you may develop your profile accordingly. So before moving ahead think about your investment nature. Based on your investment goal, you can select different profiles. Your goal can be:
1. Investment Duration
Before going for any of the investment strategies, you may need to decide how long you want to invest. This can be:
> Short Term: 0 to 1 year
> Medium: 1 to 5 Years
> Long Term: More than 5 years
The longer you invest, the higher are your return expectations. So you need to make sure that you'll be able to get it when you need it. For example if your goal is to have money at your retirement age, so you can invest for a long period like 10-20 years.
2. Income or Growth?
This is dependent on the utilization of your investment earnings. Either you can be interested to earn as income to live off during the duration of the investment or want to get return as a lump sum to reinvest. The objective of an investment is to decide the frequency and amount of return you want to get.
3. Liquidity
Liquidity means the speed in which you can convert your investment into money before the end of your investment period, without taking a loss. Some investments may be illiquid where there is fixed term feature embedded. In this case the chances of return or capital loss can be higher.
4. Risk Level Involvement
Higher returns are only available with higher risk. The risks come in two types, volatility and the performance. Volatility, depends on the up and down of your investment value. On the other hand performance depends on the chances of investment failure. Risk can be managed through multiple investments.
5. Size of investment
Selection of investment is also dependent on how much investment you have. Certain securities are size bound like bonds and TFCs. These are available in different denominations and you can select on the basis of available amount.
TYPES OF FINANCIAL INVESTMENTS
There are many different types of financial investments. Broadly speaking these fit into three asset classes.
1. Short Term Deposits/Securities
If you want to save for a short period, short term deposits can be the best option for you. Examples can be a bank deposit Account. You give the bank a lump sum for a set period (a fixed term) usually Three, Six or Twelve months. Your money is locked away for the fixed term. In return, you get a higher interest rate than you could get in a straight savings account. These deposits carry a maturity period.
Pros:
> Get Profit Quickly
> Less Maturity Risk
> More Flexible
> High Liquidity
> Capital Security
Cons:
> Only availaible in Primary Market
> Low Returns
> More Volatile to Market Conditions
> Inflation Risk
2. Bonds/ TFCs (Term Finance Certificates)
A bond is like an IOU issued by a government or a company. You give them money for a certain period and they promise to pay a certain interest rate and re-pay the principal on maturity. A bond is simply a loan/debt instrument in the form of a security with different terminology. The authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity.Bonds are issued by Public Authorities (like T-bills, Govt. bonds), credit institution and companies (in the form of TFCs).
Pros:
> Fixed Return
> Captital Security
> Secured Return
> Tradable in Security Market
Cons:
> Maturity Risk
> Inflation Risk
Bonds enable the issuer to finance long-term investments with external funds. Note that certificates of deposit (CDs) or commercial paper are considered to be money market instruments and not bonds.
Bonds and stocks are both securities, but the major difference between the two is that stock-holders are the owners of the company (i.e., they have an equity stake), whereas bond-holders are lenders to the issuing company. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely.
The most important features of a bond are:
> Nominal, principal or face amount-the amount on which the issuer pays interest, and which has to be repaid at the end
> Issue price-the price at which investors buy the bonds when they are first issued.(Face value of bond plus bond issuance fees)
> Maturity date-the date on which the issuer has to repay the nominal amount
> Coupon-the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. Coupon rate is the interest rate which you are earning on your fixed income across the period
> Coupon dates-the dates on which the issuer pays the coupon to the bond holders. This can be six monthly, annually or payment at the time of maturity.
3. Shares
Bond and shares are both securities but the major difference between the two is that stock holders are the owners of the company where as bond holders are the lenders to the issuing company/Govt. Another difference is that bonds usually have a defined term but stocks may be outstanding indefinitely.
Pros:
> Opportunity to warn High Returns
> Protection Against Inflation
> Tradable in Secondary Market
> Risk Premium
Cons:
> Company Failure Chances
> Currency Risk
> Market Risk
> Liquidity Risk
STOCK RETURNS
The profit or loss derived from an investment is the key for an investment decision. By investing in shares in a public company listed on a Stock Exchange you get the right to share in the future income and value of that company. Your return can come in two ways:
1. Dividend
2. Capital Gain /Loss
1. Dividend
Dividends are the returns corporation pays to its shareholders at the end of each financial year closer. Company earnings are distributed among shareholders in the form of dividend.
The salient features of dividend are:
> Dividends are usually settled on a cash basis, as a payment from the company to their shareholder. A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding in the company
> Sometimes companies issue shares in the form of dividend mostly called scrip/stock dividend
> Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from regular ones
> When a company declares the dividend in any form (called DECLARATION DATE) it sets a date when shareholder must be on company's books to receive dividend. This date is called RECORD DATE. Based on this date company also determines who is sent proxy statements, financial reports and other information
> Based on the Record date of the dividend, Stock Exchange sets the EX-DIVIDEND DATE which is two days before the record date. This is the cut-off date of book closure for the existing shareholders confirmation. If you purchase shares on or after Ex-Dividend date then you will not be entitled for receiving dividend.
> The payment date is the day when dividend cheques / shares are actually transferred to the shareholders of the company or credited to the brokerage accounts
2. Capital Gain/Loss
Capital Gains / Loss are the appreciation/(depreciation) of Stock value from the amount you paid to acquire shares. Capital gains are made because you're able at some time to sell your shares for more than you paid. Gains may reflect the fact that the company has grown or improved its performance or that the investment community sees that it has improved future prospects.
The salient features of Capital Gain /Loss are:
> Price appreciation / (depreciation) happens due to shares trading in the secondary market (Stock Exchange)
> The price of shares in any individual public listed company can vary from day to day. On any day some shares may go up in value and some down, depending on how investors view the prospects of each company
> And all of the listed company shares in a particular country or industry may increase or decrease in price because of rises and falls in economic confidence or changes in the particular industry
> Overall the long-term trend is for the value of listed companies to increase at a rate higher than inflation. Therefore by investing in a wide range of companies operating in a range of industries and countries, an investor has a good chance of making long-term gains
> Remember that in assessing the return from shares you need to take into account dividends received as well as capital gains. You should also expect that the dividends from the shares that you own will increase over time
This may not be a wise decision to invest short term in a very volatile stock. Shares should be used as a long-term investment.
METHODS OF STOCK INVESTMENT
1. Initial Public Offer (IPO)
A company decides to go public to raise substantial amounts of capital by offering ownership interests in the company to the public at large. The first time going to public is called Initial Public Offering. Mostly securities offered in IPO include shares, bonds, Notes, limited partnership Units, and other types of investments in the company.
Companies go public when they have a proven and profitable business model. Objective can be expansion and growth of a very profitable business or diversification within the company. But large privately-owned companies can also go public looking to become publicly traded. IPO can be a risky investment for an individual due to the unpredictability of the stock on the first day of trading.
The highlights of an IPO may be:
> The company is never required to repay the capital, but instead the new shareholders have a right to future profits distributed by the company and the right to a capital distribution in case of dissolution
> In an IPO, the issuer may obtain the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), best offering price and time to bring it to market
> Underwriter also helps companies in case of under subscription of an IPO
> Company gives advertisements in the newspaper and Stock Exchange
> There are set rules to be followed while going public
> Banks are involved to distribute and collect subscription forms and payments on behalf of company
2. Secondary Market (Stock Exchange)
Secondary market can refer to the market for any kind of used goods. The market that exists in a new security just after the new issue is often referred to as the aftermarket. Once a newly issued stock is listed in a Stock Exchange, investors and speculators can easily trade in the exchange, as market makers provide bids and offers in the new stock. Liquidity is the main benefit of the secondary market. Secondary market is vital to an efficient and modern capital market. Fundamentally, secondary markets mesh the investor's preference for liquidity.
A Stock Exchange or share market is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock Exchange also provides facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a Stock Exchange include: shares issued by companies, unit trusts and other pooled investment products and bonds.
Main features of Stock Exchange include:
> To be able to trade a security in a certain Stock Exchange, it has to be listed there
> All of the listed companies shares in a particular country or industry may increase or decrease in price because of rises and falls in economic confidence or changes in the particular industry
> Usually there is a central location at least for recordkeeping where physical shares are kept. (e.g: Central Depositary Company Pakistan)
> Trade on an exchange is allowed by members only (brokers)
> Supply and demand in stock markets are driven by various factors which, as in all free markets, affect the price of stocks
> There is usually no compulsion to issue stock via the Stock Exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that bonds are traded. Increasingly, Stock Exchanges are part of a global market for securities
> To Trade in the Stock Exchange, you must be an account holder with a member (broker) of an exchange.
Risk is the quantifiable likelihood of loss or less-than-expected return. There is always some degree present in every investment you purchase. Smart investing includes risk management. For each stock, bond, mutual fund or other investment you purchase based on your profiling, there are three distinct risks you must guard against; they are business risk, valuation risk, and force of sale risk.
1. Business Risk
Business risk is, perhaps, the most familiar and easily understood. It is the potential for loss of value through competition, mismanagement, and financial insolvency. There are a number of industries that are predisposed to higher levels of business risk. The biggest defense against business risk is the presence of franchise value. Companies that possess franchise value are able to raise prices to adjust for increased labor, taxes or material costs. The stocks and bonds of commodity-type businesses do not have this luxury and normally decline significantly when the economic environment turns south.
2. Valuation Risk
The danger of investing in companies that appear overvalued is that there is normally little room for error. The business may indeed be wonderful, but if it experiences a significant sales decline in one quarter or does not open new locations as rapidly as it originally projected, the stock will decline significantly. So as an investor you should never ask about whether the company is a good investment option, but inquire about the current price as a good option to invest in the company.
3. Force of Sale Risk
You've done everything right and found an excellent company that is selling far below what it is really worth, buying a good number of shares. In this situation this is not advisable for you to be certain about when your stock will appreciate. Do not impose a time limit because in this condition you opened yourself upto tremendous amount of risk. Because at time of need your judgment can be incorrect and turn your potential profits into losses which were missed by you due to time constraints. It is just like missing the right bus when you are in hurry.