Collective Investment Schemes (Preface)
“If you do not find a way to make money while you sleep, you will work until you die” Warren Buffet
This article, and the one that follows covers how one can grow their wealth via the use of collective investment schemes: the first one (Preface) covering some basic terms and concepts before we get into the details on which type of CIS’s are best, what’s available in Kenya, and what does one have to think about before immersing themselves in these type of investments. If the basics of investments are already a cup of tea to you, feel free to skip to https://medium.com/jipange/collective-investment-schemes-fb3148a855f0 the main article; it doesn’t hurt to refresh your knowledge on some ABCD’s of investing in various financial instruments in Kenya.
Thinking of investing? So, you have some surplus cash or you are thinking of saving towards a goal in the horizon — can be short term in the next 1 year, medium term upto three years or long term over three years — and you are looking for some means to save your money and grow it. Well, you are thinking right, and smart, and wise; quite importantly this thinking must translate into what instrument you choose to get you there. More importantly, right now you are on the right page and forum! Keep reading on!
Saving surplus cash is definitely an age old wise choice to make — keep it for a rainy day, ‘haba na haba hujaza kibaba’, ‘akiba haiozi’ — sayings taken from different cultures to emphasize the need to save, despite how little it is. Investing that cash to earn some extra income adds some flavor to the saving pudding, and there are many varied instruments to invest in. Some instruments enable your capital to earn interest or some form of regular income, some enable it to grow in value, others do both.
Wait, what the hell is a financial instrument? Financial instruments are assets that can be traded. They can also be seen as packages of capital that may be traded. Common financial instruments are shares and bonds. As an investor purchasing a share, you are giving the company issuing the shares some money in return for a piece of ownership; whereas when you buy a bond, you are lending to the issuing company some money in return for some interest every year, and your capital at maturity!
The choice of which instrument to use to invest in, and how long, and whether you prefer an instrument that gives you regular income (like dividends or interest) to one that offers instead capital gains (the company does not pay huge dividends but rather reinvests its good profits and thereby increases the value of its shares) can be a complex decision to make actively — on the go. For that reason, a good number of guys resort to the easiest instrument, bank deposits. Fix them for a period and voila! No stress! I will have my capital and earn some small percentage of interest. Before we go to the crooks of the matter — what other options are out there — besides leaving your money in a bank, let us go through these basic investment aspects individually:
Investment Horizon: This is how long you wish to stay ‘invested’ before you redeem or liquidate (sell off) the investments for cash. For the yearly family holiday this is shorter as compared to investing your money aiming to eventually build a house on that plot along Nairobi’s Eastern Bypass. For a family holiday, you should invest in an instrument which will earn something, and can be liquidated within a short time. That includes Treasury Bills, Commercial Paper, Fixed Deposits, and Call Deposits. A long-term investment horizon allows you to enter the world of shares and bonds, and their many variants.
Income vs Capital Gains Perhaps during your investment period you want some income to ‘keep you on’, we call you an income investor, whereas an investor seeking capital appreciation is happy to forego regular income for the sake of his capital gains. You see this in companies that distribute most of their income as dividends — these are the income stocks; while some reinvest their income in their business seeking to grow the company’s value, and this trickles into increased value of their shares — those are ‘capital gains’ kind of shares.
Risk Appetite: The extent that you are willing to take risk determines the investment vehicle you chose; conventional finance teaches “high risk — high reward”, but what is high risk, and what is low risk investments? You can look at it in terms of low risk, high risk and moderate risk. Low Risk — the clear intention is to preserve capital invested and earn some interest/income from that capital; an investor in this bucket does not mind the slightly lower returns as long as their initial capital remains intact/less affected by market conditions. Low risk instruments include treasury bonds and treasury bills and investment grade (strong companies with high credit ratings). With these instruments, there is almost 100% certainty that the investor will get their capital back, and hence they fetch relatively lower returns. The direct opposite of this is the high risk category, where loss of the capital is a possibility due to market downturns; common in listed and unlisted equities (shares) and over the counter instruments (not traded on mainstream licensed capital markets). An investor in the high risk category can either actively trade (sell and buy frequently) or invest for the long term (where companies go through some sort of business cycle) in order to minimize their losses if any. Moderate risk category comes in between the two perceptions of risk, and an investor in this category may for example invest in a blue chip company on the stock exchange and add in a corporate bond, with the knowledge that due to the strength of the companies they are investing in, the probability of severe and disruptive losses is minimal, at least in the short to medium term. Other terms used to describe risk appetite categories are: Risk Averse or conservative (Low Risk), Risk-neutral (Moderate), and risk seeking or aggressive (high risk).
So now that we are done with the basics, and are ready to invest let’s call the investment broker and get ourselves a Treasury Bill for December’s vacation, a Treasury Bond for the kids’ education and some Safaricom shares, because we want to earn something from our many MPESA transactions. Great! But wait, minimum investment for a T-Bill, or T-Bond, is in multiples of KES 100K and KES 50K. Oops! And we can only buy 100 Safaricom shares, which the broker says is a really small volume to trade on the main market to get a good price (they call it an odd trade!). So now, do we go back to the bank and earn some less than 5% interest per year on our deposit? Are we completely locked out of the mainstream bonds and shares market because the value of our investments is so low! That is why Collective Investment Schemes, locally known as Unit Trusts were created! For you! let’s head over to the detailed article and discuss this amazing option!
