LOUISE FAIRSAVE: Share capital risks
The previous article emphasised the point that an investment strategy must be developed on a foundation of a strong personal financial base. For example, you will be fooling yourself if you are holding a carrying balance on your credit card at upwards of 20 per cent while pursuing returns on a bank deposit or certificate of deposit of five per cent.
Of course there will be times that a very favourable investment opportunity will arise, and you may be driven to take the risk of investing in spite of your personal financial situation. You may even borrow additional funds to maximise your ride on this buoyant investment. This does happen. The result depends on the quality of your judgement and the quality of advice from your advisors.
Typically, such successful investment strategies are based on investment in the capital of business enterprises that go on to become very successful. You scrape together every dollar possible to invest in a business, most likely a start-up or lesser known company, and the stock you initially bought at, say $2 per share, rise in value to over $50 per share within a three-year period.
Similarly, many persons who become entrepreneurs hope for such returns in their venture and sometimes do generate high level of returns. Just know that business investing can take more than self-belief. The business investor needs to have a general understanding of the business in order to exercise good judgement in waiting for the maximum return as against deciding to sell his shares and get out of the investment before the share price tanks. Alternately, the astute investor may see the sense in holding on to his investment in order to await the share price recovery and acceleration into the future.
We are talking about high stakes financial risks here. If it works out, you would be a financial hero and you will be happy ever after with your financial condition. If it doesn’t for whatever reason, you will be in a deeper financial hole than before. Such high risks have worked for many an investor, while others have lost great wealth.
Investing in shares of a company therefore has its risks. As an investor, you need to understand and consider the market of that business, the opportunity to make further investment to keep the business growing, along with the likelihood of the executive management to make favourable investment decisions, the impact of the political environment, the management of cash within the business (liquidity issues), and the overall economic environment and economic trends for examples. So sometimes when investors unwittingly take such risks and they work to their advantage, they are very lucky.
On the other hand, an investor in share capital has to consider the risks of having a high portion of his investment in one particular company; the ability to convert the investment into cash at relatively short notice (liquidity risks), and the effect of inflation in the long term. Thus, many an investor’s initial foray into investing is with a balanced mutual fund where the investment manager manages a portfolio of company shares, debt instruments like government or corporate bonds, and possibly a money market component.
If you wish to be a successful investor, you need to do your homework in getting to understand the business environment enough to make reasonable predictions you are willing to bet your money on. You must consider the investment risks of the business for you as an investor. Time spent reviewing and understanding the risks of the particular business sector and of the country environment is more likely to guide your successful investing. Just do not take for granted that investment in share capital will always bring higher long-term returns.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.