COLUMNBy Moremi Marwa
Once you have a clear and well informed personal investment plan, then this should be carefully followed by the evaluation of your risk tolerance level: it is important to know that all investments involve some degree of risk. The degree of risk however, varies from one asset class (or securities with the asset class) to another.
For example, shares are traditionally known to one of the investments that have the highest degree of risk compared to other asset classes such as bonds or bank deposits. But, it is important to also remember there is a principle of investment that says: the higher the risk, the higher the return.
So, what is necessary here is for one to be able to establish the maximum level of investment that you are willing to lose in case the investment outcome goes against your expectations. In this process, it is important for you to also determine at which point in time you will need cash for other purposes, other than investing.
The point of cash need requires a careful consideration mainly because investment in listed shares should normally be looked into a medium to long term horizon. Speculative motives and “quick money” mentality shouldn’t be entertained or pursued when investing in the markets. I know some people uses this as a money making strategy (i.e. buying during IPOs and selling on a day listing), but this is as good a strategy until it is not good for you.
In your risk tolerance plans, as some advisers would put it, you psychologically should be ready or be comfortable to loose up to a third of your investment especially when moments are tough — knowing that after-all, when all is being said and done, the reward of taking on risk is the potential for a greater investment return.
If you are pursuing a goal that have a medium to long term horizon, you are likely to make more money by carefully investing in asset categories with greater risk, such as shares rather than restricting your investments to assets with less risk, like cash equivalents e.g. opening a savings account or a bank deposit. Furthermore, investing solely in cash equivalents may be appropriate for short term financial goals, even in this case one should be mindful of the inflation risk — the risk that inflation will outpace and erode investment returns over time.
Thirdly, diversification is an important element when investing in listed shares. It wise for an investors if (s)he ensures that (s)he is not overly exposed in a single company or single sector, instead an investor should spread the investment risk across a number of sectors, or companies within the same sector. In most cases, the returns of different sectors in rare cases will move up and down together at the same time. As an example, since the beginning of the year (2016), the banking sector’s performance, for various reasons, has not been at its best performance relative to the previous two decades where the sector enjoyed a compounded annual growth rate (CAGR) of 15 percent and above.
We all know that the banking sector is currently battling with challenges related to: liquidity, growth of lending activities, performance of loans, increased competition, etc. This has in a way affected their share prices, for those listed banks. So, investors who are heavily exposed in this sector suffers some loses resulting in a potential reduction of profitability (hence lower dividend) as well as lower prices of their shares upon liquidation or upon valuations.
On the contrary, by investing in more than one sector, or in more than a single entity’s shares, you will reduce the potential risk that you may lose a significant amount of money rather your portfolio’s overall returns will be less affected.
Furthermore, it is advisable that you refrain from investing all your money at the same time. In order to protect yourself from the risk of investing all your money at the same time (and in some cases that time might be “the wrong time”, it is recommended that one should follow a consistent pattern of adding new money into their investment over a period of time.
By making regular investments with the same amount of money, there are cases where you will buy more of shares when prices are at low level and less of investment when its price is high — and such a balance may save you better in terms of return on investment.
The other important factor to consider is that as you try to be a keen investor in listed shares, it is fair that you consider rebalancing of your portfolio occasionally, this will help you to minimise or manage a potential situation where your portfolio may look like it has overemphasised on one or few share categories. To achieve the portfolio rebalancing, it is important that you pursue a policy that will normalise your returns to comfortable level, given the risk taken.
Other factors to consider when investing in shares include: (i) determining your investment horizon (such horizon can be categorised as short — when up to a year; medium term, 1-5 years or long term (5+ years); (ii) identifying the industry or sector that you are mostly comfortable with (i.e. you strongly believe in banking, then you could start off with what your research and analysis will indicate as fundamentally strong banks); (iii) dividend history — if your investment objectives is regular income then a company that pays dividends on regular basis should be your portion (if this is the case, you therefore may need to ask these questions: does the company pay regular dividends or not? how attractive is the dividend yield?, etc); (iv) growth history — if your investment horizon is medium to long term and your investment goal is either children’s education or retirement purpose, then it is important for you to consider overemphasise the choice of shares for companies that have a lot of potential to increase their capital value even if yielding less dividend income in the short term; i.e. companies that pays minimum dividends because they are re-investing or retaining their earnings for expansion and future growth.
I hope this helps. But always remember: there is no guarantee whatsoever that you will surely make profits in your investment process.
Mr Moremi Marwa is chief executive officer for the Dar es Salaam Stock Exchange PLC.