If you’re familiar with Robert Kiyosaki’s cash flow quadrant you’ll know that investors have all the fun. They reap all the benefits, do little to none of the work and are paid (where profitable) like clockwork. Investors also take on the biggest risk in return for all these benefits. So the natural desire is to become an investor. Investing is for everyone but not every investment is for everybody. There are characteristics you must look for in investments to make sure they are right for you and also help you choose between investments when comparing. Any time you want to evaluate an investment opportunity these are the things you must look at to see if you and the investment are a match or not.
Ease of Buy-in
Well, we’d obviously need to start here. And this can be looked at from two equally important perspectives. Firstly let’s look at rules around buying into something. Some investments may present a challenge because of how hard the process of buying in is based on external or internal rules. Buying into a small company, for example, depends on the acquiescence of the members of the company. The other perspective is based on critical-mass thinking. For example, investing in real estate requires you to have enough to buy a house or access to mortgage finance, both tall orders in our current economy. On the opposite end investments such as Zimbabwe Stock Exchange equities can be bought with a simple application on your phone and EcoCash. So while many will shout that real estate is the best investment, what good is the best, if you cant, get in?
Ease of Exit
With investment there is risk. Real risk. Zimbabweans need very little explanation on the impact of risk on investments and how quickly a good thing can turn bad. The rational reaction for many in the face of a depreciating investment is to divest. All well and good but look at investments like real estate, if the economy is in dire straights and you want to divest from real estate chances are you’re not the only one. With many sales probably going on in the market you’re likely to have severely distressed prices on the market and real estate doesn’t sell very quickly even in a good market. But that difficulty of exit means you must endure losses longer. Contrast the commodities or equities trader who simply issues a sell or short order and they are out of the particular investment. In this space you can also think of term deposits and other investments with defined payment dates.
Degree of risk
Now risk in investing is a subject on its own that we could do a series of articles on. For the purposes of this discussion, we are going to look at a few factors that determine what sort of risk you can take on and how to identify them in investments. Time horizon, for example, is very important. Someone who invests in ZSE shares for example with the goal of making a profit in 6 months and exiting will be much more sensitive to negative shocks than someone who has a buy and hold indefinitely strategy. The shorter your horizon the more risk-averse you should be. Portfolios also play a part in this. A person with many different investments in their portfolio is likely to have a greater risk appetite than someone with no other investments. It clearly makes better sense to go with investments that suit your personal risk profile.
Compounding and accrual
This one is a bit of a mixed bag but the principle is the same. Say you lend money to a corporation or business (essentially bought a bond) which promised to pay you a certain amount based on a certain interest rate, would you want it paid out altogether with the initial amount you lent them or paid as it arises? It’s a very wide market as some can pay quarterly. However, you must also look at when the interest accrues (is calculated). Some calculate what is due to you monthly but will only pay out quarterly. I’ve mostly focused on debt but in equity markets, you have the same considerations. Say you are looking at a particular share counter, does the company pay dividends? How regularly do they pay? Do they have a Dividend Reinvestment Program (DRIP)? This allows you to direct the dividend money to buy more shares in the company instead of cashing it.
Vesting periods are expressly built into some investments while implied in others. The following example should illustrate adequately what a vesting period is. A company offers you an investment in the macadamia nut farming business. You pay them a certain amount that will be used to plant and care for the tree. The tree will start paying you rewards after 6 years. The payout amount is specified but you cannot get the money from the tree in years 1-5. So there is a vesting period. While promises of 20% or more gains are valid they are not accessible. The same can be experienced by those who invest in antiques as valuables or growing businesses.
I already touched on liquidity when it comes to how difficult it may be to sell real estate. Liquidity is important and while linked to ease of exit it is not quite the same issue. Term deposits, for example, offer high-interest rates provided you leave your money in the account for a certain amount of time. So these are highly illiquid. Well not entirely but usually there are massive penalties for attempting to cash out early. Not worth it in most cases. Real estate is also up there with the illiquid investments as arranging a sale is a process and that’s before we factor in the economy. Investments in private businesses can prove difficult to liquidate because of the same reasons buy-in was difficult. There are other types of high-interest savings accounts known as call accounts which require you to give notice before withdrawing, this can be 7, 21, 30 or 60 days notice. Shares and other securities are highly liquid as are most commodities. You can pretty much sell them on the day because of the active market.
The factors above are all important but not to be looked at in isolation. What is your investment goal? Are you looking save up for a specific item like a car or holiday? Retirement perhaps? Or looking to grow your asset base. What’s important is knowing how each of these factors is handled in the investment opportunity you are looking at.