Using capital market tools to grow wealth
Capital markets form a key cornerstone in the wealth creation journey in that there are different products to take care of the various risk appetites and return expectations. Before proceeding let us define what capital markets are.
These are organised markets where financial instruments trade. The people in need of capital go there to raise capital while people who have excess capital go there seeking to generate returns. There are different forms of products that trade in the markets but they generally take two broad forms i.e shares and bonds.
Shares are units of ownership in a company and the investor participates in both the profits and the loss of the said companies. Bonds are long term loan instruments and they can be issued by both corporates and the government.
Participation in the capital markets can be done either directly by purchasing the units from the issuer or indirectly through the purchase of units into funds that have invested in the underlying securities. The most known forms of indirect investments are the unit trust funds.
Over time we have seen the development of capital market instruments both in the publicly traded space and the private markets. Some of these include derivatives products, Real Estate Investment Trust (REITs), and on the private end, we have asset-specific funds, private equity funds playing across the various life cycle of the companies, for example, venture capitals.
When investing in the capital markets it is always good for one to know the key players in the space and do their due diligence so that one can select a firm that they like and are compatible with.
Some of the key players in the capital markets would include:
i) a regulator- Capital Markets Authority
ii) Brokers and Agents
iii) Fund Managers and
(iv) Investment Advisors among others.
There are some products that are not directly within the capital markets space but they enable investors to cash in on the capital markets eg the main retirement benefits funds and some of the Insurance funds. It is always good to understand the funds' mandate even as we select the one to invest in.
When one chooses to invest in the capital markets it is good to put into considerations the below key factors:
1. Financial literacy levels: Investment is not gambling and so one should invest in that which they truly know and understand. If a product does not make sense to you as an investor it is always good to take time to research and understand how the returns are to be derived. Until when you can speak to it, one is advised not to invest in it;
2. The investment horizon: Each investment has its own measure of risk and it is, therefore, important as one is investing for very specific goals, they should ensure they match the returns i.e the income and the principle with the need requirement for the same;
3. The investment amount: There are some investments that have prescribed minimums and so one cannot invest if the amounts they have is lower than that. Also, some investments could be too low to make any meaningful contribution to one’s overall income or it could be too much, meaning investors are opening themselves to a lot more risk;
4. Return expectations: The expected returns from the various products vary and it is for this reason that one should understand how the returns are made, see if the returns make sense and if they meet the expectations, if not, one may consider looking into other products.
5. Investment risk: Investments involves some level of risks and it is for this reason that one needs to understand the risk they are taking. If for example, one is investing in a company, i.e taking both equity and bond investments, equity investments is generally riskier than bond investment.
6. Taxation status: Different investments and individuals have different taxation treatments and so one should know the tax regimes so that they can plan accordingly. At the end of the day, the investors should look at their investments on a net of tax basis.
7. Liquidity of the investments: Liquidity refers to the ease at which the investments can be converted into cash. Liquidity level affects both the return and the risk perceptions of the investments. It is therefore important that one looks at this and ensure that they are getting well-compensated in case the product is illiquidity, get a liquidity premium.
8. Investors monitoring time available: Active management of some investments might require a lot of time e.g investments in shares. It might make sense if one does not have too much time to buy into funds that have active fund managers.
The reasons why investing in the capital markets is important are: It demands less time on you as the investor as long as you have decided on what you need, the investor gets to get access to some of the best analyses that can aid in decision making from both the sale side and the fund managers, and also one can invest in the capital markets incrementally so learning on the go.
One of the main decisions that one should make at the onset is the investment partners that they shall need and select one that is aligned to your success. Seeking knowledge and speaking to experts as you start is the first most important step.
The writer is a personal finance expert [email protected].
