Last week we talked about developing a savings culture, an investment culture goes hand in hand with this.
Money which is left in the bank can be used more productively provided one can assess the risks involved.
The risks determine the structure of investment portfolio. Before one considers the profits one must know the risks.
Investment portfolio is a big word but it basically means the range of investments you have; be it land, shares, cash, cars, businesses or any ventures you may have.
This portfolio is susceptible to pressures and factors that are sometimes beyond your control. You must try to reduce the controllable risks and mitigate for the ones beyond your control.
The one thing that investment analysts all agree on is diversification, that is spreading the risk across several sectors to mitigate the following.
Market risk – If one were to invest heavily in one sector, then they are liable to suffer if that market falls.
Competition within the market can also drive down your profits, costs can rise within the sector cutting margins and so forth. So diversity is the key to survival. It better to have several slow earners than a big earner that could go bust tomorrow.
Liquidity risk – A business or even a person can often have a sudden need for cash to cover unforeseen events.
Assets often have to be sold or loans taken to cover such expenses and this can affect the health of a business. One must leave a reserve of cash, as well as assets that can be converted quickly into cash when necessary.
Financial risk – Ventures that are funded on credit are heavily affected by changes in interest rates, inflation, currency appreciation and the like. Many borrowers are now fully conversant with compound interest, as well as penalty charges for delayed payments.
Currency risk – This arises when the local currency fluctuates in relation to regional and international currencies.
A person who borrows money in foreign currency is particularly prone to this form of risk. If for instance one were to borrow in US dollars when they earn local currency, any changes in the dollar affects them.
In order to mitigate for such risks in you personal business affairs one should ideally have 4 types of investment or businesses.
Cash flow– this is the business that provides daily cash, for example a shop or your job. For a steady tream of income, a shop would have what is called float money. This is money it uses for daily running costs and this can be used in emergencies.
This takes care of liquidity risk but is prone to market risk and currency risk.
Slow burner – this is an investment that appreciates slowly over time. Putting money in a high-interest savings account long-term can count as a slow burner such as buying shares in a business or buying under-valued property.
One has to look at a minimum 10-year period for a slow burner. It insulates you from short-term events and currency risk.
Prestige – this is an asset that is of high personal value to you which can also be converted into cash in a relatively short time. Property always holds its minimum value and often increases in value provided a property is well maintained.
The final investment is the most important – Innovation is the key to investment, you have to spot the next big thing before the next person does.
Always devote a portion of your investment money for innovation. A person who invested $100 in Microsoft in 1988 now would have shares worth $2 billion.
Look around in your local area for new opportunities and you might strike investment gold!