How to reduce investing risks

All investors, whether in stocks or fixed-interest instruments, have to continually weigh the various risks associated with their investments. Money in a savings account assumes no risk factor, since the return is precisely what was originally expected. Further an investment (for example, com­mon stock) moves away from expected return, greater the risk. In short, risk can be defined as uncertain return.

While there are dozens of financial variables at play, from the health of the President to the level of housing starts, from the price of the country's currency in the foreign exchange market to the central bank's discount rate, the major sources of risk can be reduced to three categories.

The 3 most important investing risks

1. Interest rate risk

Since interest rates determine the price of borrowed money, changes in interest rates have a vast impact on investments, particularly since so many investors borrow money, whether for investing or to finance other purchases.

Budget deficits require the central government to borrow massive sums. The auction of treasury paper to cover these deficits is perhaps the chief element in setting interest rates, but other factors such as the bank interest rates, plus fiscal and monetary moves, all have their effects.

Interest rate changes are first felt in the fixed-income - or debt instruments, and subsequently in the stock market. So far as fixed income instruments are concerned, their values (prices) fall when interest rates rise, and go up when interest rates fall.

There is a tipping point - in the US generally thought to be about 10 per cent in the case of long tenor bonds, or when the spread between stock yields and money market funds becomes excessive, say 7 or 8 per cent - where the stock market can no longer compete with higher yields offered by the fixed-interest market.

At that point, i.e. when prevailing interest rates become so high, money flows out of stocks and into bonds. The perception of higher inflation - and higher interest rates to compensate for it - suggests that stocks are definitely subject to interest rate risk.

2. Company risk

If interest rate risk is first felt in the bond market, company or business risk is first felt in stocks. The risk, simply put, is that the company whose shares you have bought may go belly-up. While a bond or debenture holder has some recourse to the company's assets in such a situation, the stockholder is left to the mercies of the exchange.

Individual companies are open to the vagaries of business cycles, government policies, product and technology changes, management skills, labor relations, commodity shortages, hostile takeovers and natural calamities.

No two companies are affected in the same way, so company risk is sometimes called firm-specific risk or unsystematic risk, since what befalls one company does not usually have any bearing on another Clearly, each company's vulnerability is somewhat different and in some ways contradictory. Thus, if you own shares of a number of companies in your, the unsystematic risks will tend to cancel one another.

A diversified mutual fund of hundreds of companies all but eliminates unsystematic risk, but investors can achieve almost the same benefit by diversifying their holdings with 10 or 15 securities. Since diversification can eliminate most company risk, unsystematic risk is an unnecessary one to bear. In brief, prudent portfolio management requires canceling most company risk.

3. Market risk

Forces that affect the whole economic system and bear directly on the markets are generally inescapable. Like the spring rain, they fall equally on all, and no amount of portfolio diversification reduces vulnerability.

Some of the market risks - also called systematic risks - are political and legislative, such as the election of a new government and new tax codes; others are economic and financial, such as a recession or adjustments in currency value. Actions that affect all players are market risks, even though all participants may not be equally impacted. System-wide risk moves the stock market, as well as individual stocks, up and down.

The measure of this market volatility is termed beta, which equals unity, or 1. Specific securities can be mea­sured against that general beta: They can be more volatile and have a beta of 1.5, or less volatile with a beta .5; the former is 50 per cent more volatile than the market, while the latter is half as volatile as the general market. The beta evaluation (based on a mathematical formula) is a measurement of market or systematic risk.

There are other types of risks or uncertainties, such as the future value of currency or purchasing power risk, but the three - interest rate, company and market - are the ones of greatest concern for investors.

How you can reduce risk

To some degree, investors can manage risk, or at least make it tolerable. Each type of risk can be countered by employing some market tactic. This will assist in fine-tuning the amount of exposure that comes with each risk situation.

For example, an investor can handle interest rate risk by appropriate timing to offset interest rate moves after careful study of the business cycle. An investor will try to lock in high yields if interest rates are about to fall (shortly before a recession commences) and, conversely, sell fixed income securities if interest rates are about to rise (when business starts to accelerate dramatically).

Market risk can be reduced, as noted earlier through proper diversification. Most investors make the mistake of buying only two or three securities. Economists have calculated that a portfolio comprising of shares of 12 to 15 of different companies will eliminate 91 per cent of all unsystematic or company risk.

To elimi­nate the remaining business risk, you would have to buy hundreds of more companies. Since that is obviously im­practical, it is perhaps wise to buy mutual funds until such time as your resources are ample enough to permit you to buy a dozen different issues.

Finally, diversifying in time can reduce market risk. By constantly investing both during good times and bad, when the market is high and when the market is low, it is possible to average your way to lower prices or, conversely, increase your rate of return. Obviously, timing is a major concern to investors.

There are two possible solutions to the problem of timing: you can either develop the skills and talents necessary to trade the market, or side-step the problem altogether by using one of the formula investing strategies such as dollar averaging or systematic investment planning plans. The former will appeal to active traders, while the latter is attractive to long-term investors.

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Excerpt from:
The Basics of Stocks
Author: Gerald Krefetz
Gerald Krefetz is a principal of Krefetz Management and Research, he runs a private money management service for individuals in Manhattan, U.S.A. and has written more than twelve books.

Financial stocks remain investors’ favourite

The stock market opened on a low note on Monday as the volume of shares traded and other market indicators closed lower compared with Friday’s figures.

Investors had invested N9.26bn on 603.94million shares in 10,917 deals on Friday while the Nigerian Stock Exchange All-Share Index and market capitalisation dipped by 0.5 per cent.

When the market opened for business on Monday, investors traded only 511.86million shares worth N7.08bn in 10,289 deals.

The Index dipped further by another 0.03 per cent from 51,084.75 to close at 51,068.40 just as the market capitalisation fell from N7.854tn on Friday to close at N7.852tn on Monday.

A stockbroker had on Friday, attributed the bearish trend to portfolio review by some investors and profit taking by others.

“Some are selling to reap capital appreciation while others are selling stocks on which they had recorded growth to invest in some offers to open in the primary market soon,” he said.

Mobil Oil Nigeria Plc led the price losers for the day with N4.96 to close at N165.19 per share. Conoil Plc and Nigerian Bottling Company Plc followed with N3.14 and N2.60 to close at N60.86 and N49.40, respectively.

On the other hand, Flour Mills Nigeria Plc led the gainers with N3.75 to close at N78.75. Guinness Nigeria Plc chalked up N1.50, while Benue Cement Company Plc and R.T. Briscoe Nigeria Plc garnered N1.49 and N1.39 in that order.

However, he banking and insurance sub-sectors remained investors’ favourites. The banking sub-sector led with 292.65million shares valued at N4.64bn, while insurance stocks sold 111.68million shares worth N455.59million.

Fidelity Bank Plc led the banking sub-sector with 138.71m valued at N1.45bn traded in 629 deals. The stock had been very active in the past weeks.

The Corporate Affairs Manager of the bank, Mr. Emmanuel Esinna, attributed the high patronage to the improved financial performance of the bank.

According to him, the bank had recorded over 200 per cent rise in its third quarter results while investors were expecting better results for the full year ending June 30, 2007.

Wema Bank Plc sold 26.23million shares worth N289.81m in 652 deals, while IBTC Chartered Bank Plc traded 13.58million shares valued at N149.34m in 69 deals.
Courtesy African capital market daily news.

DEMYSTIFYING BONDS

Bonds are legal instruments used by Governments (Federal, State and Local), Companies and other entities to borrow money from the public.

The entity borrowing money by way of a bond is called the issuer and the person investing is the buyer.

The issuer of a bond promises to pay the buyer interest, which is called a coupon for the privilege of using the buyer's money. The issuer also promises to return the money, which is the principal to the buyer on a specified date. This is called the maturity date.

The coupon which, is a predetermined interest amount, is paid to the buyer at periodic intervals, throughout the life of the bond. It is this nature of known periodic interest amount (coupon) and known principal amount that gave rise to the nomenclature 'fixed income securities' given to bonds.

Why opt for Government Bonds?

If you are an investor looking at investing money for a period longer than 1 year, or tend to have deposits or placements that have been running for more than a year, Government bond investment will likely suit your investment appetite.

Government bonds provide a desirable savings or investment vehicle for many reasons. They tend to be safer than stocks because if you hold bonds until the maturity date, you don't risk the principal. However if you need to sell your bond before its maturity date, you may lose or gain a bit depending on the ruling price at the point of exit. Without exiting prematurely, Government bonds provide a regular, steady source of income (typically, interest payments are received every 6 months).

Advantages of Government Bonds are:

· They pay higher interest rates than savings accounts.

· They offer a relatively safe return of principal.

· They often have less volatility (price fluctuations) than stocks, especially short-term bonds.

· They offer regular income.

· They are sold in small Naira amounts (N10, 000.00).

· They need less careful attention in management than other alternative investments.

· They are exempted from federal income taxes and possibly from state and local income taxes.

· They are a good way to diversify a portfolio and help to meet investors' income objectives.

Investing In Mutual Funds.

What factors drive your decision to invest?Every form of investment involves a certain level of decision making. These decisions often depend on information, perceived views and available data, to mention a few. People hold different views when making investment decisions and this is evident in the outcome of their investment. There are those who believe that investing is nothing more than a game of luck and therefore, investing is reduced to the act of “tossing a coin”. Others believe in the prospect of doing some research to achieve results. While the former is often discouraged, the latter can only be beneficial if certain factors are considered. Your investment objective is the most important factor to be considered when investing. However, in this article, we will be focusing on other factors that drive your mutual fund investment decisions.Determining what stage you fall into in the financial life cycle A key to being a successful investor is the ability to determine what stage you are in the financial life cycle. It is believed that an individual may fall into any of the following categories;· Accumulation Stage – (Below 30 years)· Consolidation Stage – (30 – 55 years)· Spending & Gifting Stage (Retirement) – (Above 55 years)While these stages vary in definition by various financial advisors, they serve as a guide in determining what and where your funds should be invested. For example, a young man in his late 20s can afford to take significant risk and hence, invest in equity-based mutual funds. However, if he gets to a point in his financial life cycle that shows that he is better off in less risky investments, he should be willing to make the needed changes, say, from an equity mutual fund to a money market mutual fund. An investment adviser can assist in determining the characteristics and requirements of each stage and proffer the options that suit you. Balancing Optimism and Perceived RiskNo investor wants to make a loss when investing, even though it is a fact that the value of your investment may go up or down. Bearing this in mind, how do you balance your optimism that the outcome of your investment will be positive with the risk you perceive on such investments? Generally, a successful investor will find the need to be optimistic very helpful and as much as possible, avoid creating room for pessimism. This helps to maintain a healthy outlook on the outcome of your investment. Investing usually involves a leap of faith supported by hard data and this leap turns out to be justified over the long run as long as all indicators (including the fund manager’s decisions) point to the possibility of positive performances over the long term. However, many people make snap decisions due to what they perceive as imminent risks in order to avoid total loss. You can manage this position by assessing your personal risk tolerance and comparing this with a mutual fund's risk level to determine the suitability of the fund to realizing your investment objective. Focusing on “long term” performanceMost Mutual Funds are known to be beneficial, usually over the long term. This is because they are structured to ride the different market conditions. Whilst an investor’s needs differ, a successful mutual fund investor must think long term! Short-term investors strive to make a lot of money over a relatively short time period, preferring to believe that the future is largely unknown, while long-term investors appear to be much more able to disregard present performance, and willing to earn even moderate returns, but over an extended period. Although the short-term investment is not totally devoid of merit and may work out well for some, usually over a limited period of time; a sizeable number of short-term investors wind up well short of their goals. The beauty of compounding returns can only be appreciated by a long-term investor whose investment appreciates to larger sums over the years.By considering these factors, you are better able to make sound decisions which will reduce the odds of the unexpected happening.
What factors drive your decision to invest?Every form of investment involves a certain level of decision making. These decisions often depend on information, perceived views and available data, to mention a few. People hold different views when making investment decisions and this is evident in the outcome of their investment. There are those who believe that investing is nothing more than a game of luck and therefore, investing is reduced to the act of “tossing a coin”. Others believe in the prospect of doing some research to achieve results. While the former is often discouraged, the latter can only be beneficial if certain factors are considered. Your investment objective is the most important factor to be considered when investing. However, in this article, we will be focusing on other factors that drive your mutual fund investment decisions.Determining what stage you fall into in the financial life cycle A key to being a successful investor is the ability to determine what stage you are in the financial life cycle. It is believed that an individual may fall into any of the following categories;· Accumulation Stage – (Below 30 years)· Consolidation Stage – (30 – 55 years)· Spending & Gifting Stage (Retirement) – (Above 55 years)While these stages vary in definition by various financial advisors, they serve as a guide in determining what and where your funds should be invested. For example, a young man in his late 20s can afford to take significant risk and hence, invest in equity-based mutual funds. However, if he gets to a point in his financial life cycle that shows that he is better off in less risky investments, he should be willing to make the needed changes, say, from an equity mutual fund to a money market mutual fund. An investment adviser can assist in determining the characteristics and requirements of each stage and proffer the options that suit you. Balancing Optimism and Perceived RiskNo investor wants to make a loss when investing, even though it is a fact that the value of your investment may go up or down. Bearing this in mind, how do you balance your optimism that the outcome of your investment will be positive with the risk you perceive on such investments? Generally, a successful investor will find the need to be optimistic very helpful and as much as possible, avoid creating room for pessimism. This helps to maintain a healthy outlook on the outcome of your investment. Investing usually involves a leap of faith supported by hard data and this leap turns out to be justified over the long run as long as all indicators (including the fund manager’s decisions) point to the possibility of positive performances over the long term. However, many people make snap decisions due to what they perceive as imminent risks in order to avoid total loss. You can manage this position by assessing your personal risk tolerance and comparing this with a mutual fund's risk level to determine the suitability of the fund to realizing your investment objective. Focusing on “long term” performanceMost Mutual Funds are known to be beneficial, usually over the long term. This is because they are structured to ride the different market conditions. Whilst an investor’s needs differ, a successful mutual fund investor must think long term! Short-term investors strive to make a lot of money over a relatively short time period, preferring to believe that the future is largely unknown, while long-term investors appear to be much more able to disregard present performance, and willing to earn even moderate returns, but over an extended period. Although the short-term investment is not totally devoid of merit and may work out well for some, usually over a limited period of time; a sizeable number of short-term investors wind up well short of their goals. The beauty of compounding returns can only be appreciated by a long-term investor whose investment appreciates to larger sums over the years.By considering these factors, you are better able to make sound decisions which will reduce the odds of the unexpected happening.

THINGS TO CONSIDER BEFORE INVESTING IN DEBENTURES OR LOAN STOCKS.

Debentures and loan stocks are not same as common or ordinary shares.They are basically debt instruments issued by companies or goverments in order to make use of the investors money which will be repaid with cash or shares on a given date.
Always put the following into consideration before investing in debentures or loan stock.
1. Interest rate - Debentures pay interest that can be fixed,floating or payable at maturity.You need to be confident that the interest rate would remain competitive during the tenor of the debenture before you invest.
2. Credit risk - This refers to the ability of the company or government agency to make timely payments of the interest and principal (actual amount borrowed) to the investor.Borrowers are now required by law to obtain a rating from rating agencies.The rating serves as a good measuring stick for the safety of the debenture.Please avoid investing in debentures with poor ratings.
3. Maturity - This refers to the specific future date on which the investor's principal will be repaid.Debentures or loan stocks that can be paid by the company or government agency are called redeemable debentures while debentures that cannot be paid but rather converted into shares at maturity are called convertible debentures.
I hope the above tips will be helpful.

Testing.