LOUISE FAIRSAVE: Investing basics
IN THE CYCLE OF LIFE, our first asset is typically a bank or credit union account. Later on, we may take a mortgage or a personal loan in order to purchase our first home, first car, furniture or more costly personal items.
This represents the basic first two stages of investing. This article explores the more unfamiliar third stage of investing in financial assets.
A financial asset or security is a certificate which is a legally binding record that the owner of the security has either lent money to the issuer of the security, or has purchased shares or equity in the issuing company or the issuing entity. So, there can be debt securities or equity/ownership securities.
Debt securities are called bonds, debentures or notes, and equity securities are called shares in the entity or stock, options to purchase shares and other sophisticated equity investment vehicles. Shareholders own part of the entity and have rights and privileges according to the rules of the entity.
In earlier days, such securities were paper certificates. However, with the development of the digital technology and of central securities depositories, some securities, particularly publicly traded securities, are no longer evidenced by a paper document.
A central securities depository is a financial organisation which holds securities either in a certificated (on paper) or uncertificated (dematerialised) form.
This allows ownership to be easily transferred through a book entry as against having to locate and hand over the securities certificate when the security is sold.
Brokers are specially qualified investors who may transact business in the financial market on behalf of individuals or investment houses. A person representing a broker is called a trader.
Financial or capital markets are the trading places where financial assets are bought and sold. There is the money market which deals in short-term securities. These are securities that are readily marketable and can be sold within a year if necessary.
There is also the main capital market which deals with the longer term securities. It is comprised of the stock exchange, stock brokers, dealers and traders.
When securities are purchased (through a broker) directly from the issuing entity and the proceeds of the sale go to the issuing entity, that transaction is described as done on a primary market, for example, shares bought in an initial public offering.
On the other hand, when existing securities are bought or sold, that is a secondary market transaction. In this case, the proceeds of the sale go to the holder of the security or the selling shareholder if they are equity securities, and the buyer of the security becomes the new security holder or shareholder.
Capital markets allow funds to flow from investors who have funds available to invest to the businesses or government which need the funds.
This is done through financial intermediaries such as brokers, dealers, investment brokers and such middlemen. Particularly if you wish to deal in shares of a public company, you will need to engage a qualified broker to act on your behalf.
Commercial undertakings, governments and even individuals seek funds to expand their business, buy equipment or real property, or to finance a novel enterprise. They come to the capital market to meet those who have funds to invest – other business and commercial undertakings and individuals.
From a personal finance point of view, your incentive to invest in the capital market is to earn passive income. Your expectation is to earn a return high enough to outpace inflation and so grow your net worth over time.
• Louise Fairsave is a personal financial management advisor, providing practical advice on money and estate matters. Her advice is general in nature;
readers should seek advice about their specific circumstances.
Email: [email protected]