How to choose your investment approach

July 9, 2009
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, NAIROBI, Kenya, Jul 9 – Traditional savings accounts offer a high degree of security and are an essential part of a balanced financial portfolio. However, the prospect of growth can make a real difference to your financial position. Investments in stocks and shares have generally produced long-term returns that have both offset the negative impact of inflation and significantly outperformed returns from traditional savings accounts.

Investors need to learn to choose their investment approach wisely and most of the time this will need the help of an investment adviser. There are many influences that will impact how you choose to invest your money. Your investment adviser will discuss the most suitable approach for you based on your personal circumstance and how and when you are likely to take the benefit of your investment.

This will also be heavily influenced by your own personal approach to risk. While some people are more adventurous than others, choosing investments that offer the potential for greater returns and are prepared to accept a high degree of risk, there are some who will be more cautious and invest accordingly.

Most investments are risk rated so as to assist you to select options that fit with your approach to risk. Low risk investments are suited to those who require a high degree of security as they offer low risk growth potential. Cash and cash equivalents such as savings, deposits, certificates of deposits and treasury bills have the lowest risk amongst the three asset categories. The chances of losing money on an investment in this asset category are generally extremely low.

The principal concern for investors of cash equivalents is inflation risk. This is the risk that inflation will outpace and erode investment returns over time.

Medium risk rated investments are for investors seeking the potential of growth over the medium term as they invest in the world’s major equity markets. Medium risk investments may also involve investments in bonds. Bonds are generally less volatile than stocks but offer more modest returns.

As a result, an investor approaching a financial goal might increase their bond holdings relative to their stock holdings because the reduced risk of holding more bonds would be attractive despite their lower potential for growth. Some categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk. However, it should be noted that potential for superior growth is balanced by increased risk of price fluctuations.

High risk rated investments are for investors seeking the potential of superior capital growth. However, it is important to note that although these markets have the potential to deliver high returns, this can be offset by large falls during periods of adverse volatility. The high risk to reward ratio of these funds usually makes them suitable only for a small part of a structured portfolio.

Stocks have the greatest risk and highest returns among the three major asset categories historically. However, the volatility of stocks makes them a very risky investment in the short term. Investors with long-term investment objectives need not to worry about short-term volatility because of the strong positive returns.

Bonds are generally less volatile than stocks but offer more modest returns. As a result, an investor approaching a financial goal might increase their bond holdings relative to their stock holdings because the reduced risk of holding more bonds would be attractive to the investor despite their lower potential for growth. Some categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk.

(Renaldo D’Souza is the Marketing and PR Coordinator at Winton Investment Services Ltd, an Offshore Investment Advisory Company based in Nairobi)

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