Investment Securities and Financial Planning

Welcome to your essential guide on Investment Securities and Financial Planning! Understanding how to manage and grow your money is a crucial skill for financial success. This comprehensive breakdown will cover key investment concepts, types of securities, factors influencing investment decisions, and practical financial planning strategies, perfect for students navigating the world of finance.

Unpacking Investment Securities and Financial Planning: Core Concepts

Investing is the act of saving money to yield better returns over time. The journey into investment securities and financial planning involves understanding various terms and markets. Let's start by defining some fundamental concepts:

• Investment: Investing or saving money to yield better returns.
• JSE (Johannesburg Stock Exchange): A formal market for trading shares of public companies, serving as an economic indicator for South Africa.
• Share: Gives investors part-ownership of a company.
• Capital Market/Securities Market: A market where companies and governments raise long-term funds by trading securities.
• Short-term Investment: An investment for less than one year.
• Long-term Investment: An investment for longer than one year.
• Fixed Rate: The rate of return remains constant for the investment period.
• Accumulated Interest: Interest earned over the investment period.
• Simple Interest: Calculated only on the original/principal amount invested.
• Compound Interest: Calculated each period on the original amount, plus all interest accumulated from past periods.
• Risk: The chance that the invested amount may decrease in value or be lost due to unforeseen circumstances.
• Debentures: Issued to raise borrowed capital from the public; debenture holders are creditors.
• Dividends: Regular payments from a company to its shareholders, representing a portion of profits.
• Capital Gain: The return from an asset's appreciation in value over time, often subject to capital gains tax when sold.

Functions of the JSE: The Heart of Securities Trading

The Johannesburg Stock Exchange (JSE) plays a vital role in the financial landscape, offering numerous functions that support investment securities and financial planning:

• Provides opportunities for financial institutions (e.g., insurance companies) to invest funds in shares.
• Serves as a barometer/indicator of economic conditions in South Africa.
• Keeps investors informed on daily share prices.
• Acts as a link between investors and public companies.
• Shares are valued and assessed by experts.
• Encourages small investors to participate in the economy.
• Makes venture capital market available.
• Ensures an orderly and disciplined market for securities.
• Mobilises funds from institutions and encourages new investments.
• Raises primary capital and regulates the share market.
• Plans, researches, and advises on investment possibilities.
• Ensures market transparency and protects investors.
• Encourages short-term investment and facilitates electronic trading via STRATE.

Key Factors for Smart Investment Decisions

Making informed investment decisions is crucial for effective financial planning and investment securities management. Consider these factors:

Return on Investment (ROI) and Risk Assessment

• Return on Investment (ROI): This includes interest, dividends, or capital growth. It should be expressed as a net after-tax gain and ideally be higher than the inflation rate. Generally, higher risk investments offer the potential for higher returns.
• Risk: The potential for investment loss. Different investments carry different risk levels. Shares, for instance, have low to medium risk over the long term, but ordinary shares carry the highest risk due to potential loss upon company liquidation. Share prices are volatile and influenced by external factors like economic conditions.

Investment Term, Inflation, and Personal Budget

• Investment Term/Period: The duration of your investment (short, medium, or long-term) impacts returns. Longer terms generally yield higher returns.
• Inflation Rate: A high inflation rate reduces purchasing power. Your investment return should exceed inflation to maintain real value. Inflation can positively affect investments like property or shares where income increases with inflation.
• Personal Budget: Determine surplus money available for investment. Budget for unforeseen costs and create contingency plans or savings.

Liquidity, Taxation, and Market Volatility

• Liquidity: How easily and quickly an investment can be converted into cash. Savings accounts are highly liquid; fixed deposits are less so.
• Tax Implications/Taxation: Consider income tax implications to ensure a high net after-tax return, as tax rates vary for different investments.
• Fluctuations/Volatility of Investment Markets: Economic stability, national and international trends influence investment values. High volatility determines the amount of returns and can lead to sharp increases or decreases in value.
• Track Record/History/Performance: Research the business/sector's past performance.
• Additional Costs: Account for administration fees, brokerage, and other applicable charges.

Investment Planning Factors

• Prioritise the safest possible investment opportunities.
• Sometimes, lower income on invested capital is acceptable for a safer investment.
• Examine opportunities with a history of good returns.
• Diversify investments across various options.
• Understand the method for calculating interest/return on investment.

Exploring Diverse Investment Opportunities and Their Risks

Investment securities and financial planning involve choosing from a range of opportunities, each with unique characteristics and risk factors:

1. RSA Retail Savings Bonds (Government Retail Bonds)

These bonds encourage saving among South African citizens, offering fixed-rate or inflation-linked options.

Positives:

• Guaranteed returns with fixed interest rates for the entire period.
• Market-related interest rates paid twice a year.
• Easily accessible after 12 months (with penalties for earlier withdrawal).
• Low risk, as it's invested with the South African Government.
• Affordable, with a minimum of R1,000, and no charges/commissions.
• Conveniently obtained electronically, from Post Offices, or National Treasury.
• Can be inherited and encourages saving from a young age (minors can invest with a legal guardian).

Negatives:

• Cannot be ceded to banks as security for loans.
• Not freely transferable among investors.
• Requires valid SA identification and being over 18 (discouraging foreigners/young people).

Risk: Very low, as the investment is with the government and not exposed to market risks.

2. Unit Trusts

A collection of investment options pooling funds from multiple investors, managed by a fund manager.

Positives:

• Managed by accredited experts.
• Offers a variety of shares, spreading risk.
• Regulated and safe investments.
• Allows small monthly investments.
• Easy to invest and cash in.
• Fluctuations are often less severe due to diversity.
• Generally beats inflation over the medium/long term, offering competitive returns from capital growth and dividends.

Negatives:

• Share prices can fluctuate.
• Performance relies on underlying companies' growth.
• Not allowed to borrow, potentially reducing returns.
• Bid/ask prices mean buying is usually higher than selling, making it less liquid.
• Not ideal for short-term investors or those wanting to avoid all risks.

Risk: Risk is spread and managed by the fund manager due to diversified investments in high and low-risk shares.

3. Shares (Ordinary Shares)

Companies issue portions of ownership to shareholders to obtain capital. Shares give voting rights and the right to receive dividends.

Positives:

• Higher shareholding can lead to higher proportional dividend payouts.
• Freely transferable/traded on the JSE.
• Shareholders have limited liability for company debts.
• Voting rights at the Annual General Meeting (AGM).
• ROI is linked to company performance.
• Provides protection against inflation and solid returns at retirement.
• Ordinary shares are often cheaper than preference shares.

Negatives:

• Dividends may be low or non-existent if company profits are low.
• Companies have no legal obligation to pay dividends.
• High risk; investment can be lost upon company liquidation.
• Dividends are determined by management.

Risk: Ordinary shares have the highest risk, with potential full or partial loss upon company dissolution. Share prices are volatile and unpredictable due to economic conditions and company success.

4. Fixed Deposit

A conservative investment method at a fixed rate for a fixed period with a financial institution.

Positives:

• Interest earned at a fixed rate, unaffected by economic climate changes.
• Flexible investment periods (short/medium/long term).
• Ensures financial discipline as funds cannot be withdrawn before maturity.
• Better returns than ordinary savings accounts.
• Principal and interest paid out on maturity.

Negatives:

• Funds cannot be withdrawn before maturity.
• May not outperform inflation over the long term.
• Low returns compared to other investments.

Risk: Very low, as investors receive what was promised. Interest rate is usually fixed, insulating returns from market fluctuations.

5. Managed Portfolio

An investor instructs a financial institution to manage their various investments in one portfolio.

Risk: Lower over a longer term due to diversified investments. High risk over the short term due to market volatility impacting capital market investments.

6. Debentures

Issued to raise borrowed capital; debenture holders are creditors receiving annual interest payments.

Risk: Low risk, as companies are liable to repay the principal and interest. Investors earn steady income while preserving principal.

7. Fixed Property

Buying land or a house, typically a long-term investment.

Risk: Low risk over a long term. Value can be influenced by economic conditions.

8. Mutual Funds/Stokvels

Informal savings schemes where members contribute, and each takes a turn to draw from the fund.

Risk: Schemers can run illegal pyramid schemes, leading to loss of savings. Savings accounts within stokvels are safe but offer low interest rates.

9. Business Ventures/Venture Capital

Investment given to start or expand a business in return for a share.

Risk: High risk if research is not properly done or due to inexperienced business owners making wrong decisions.

10. Endowment/Life Insurance Policies/Retirement Annuities

Monthly payments to an insurance company with the expectation of receiving a pre-determined amount in the future.

Risk: Low risk, as the insured amount will be paid out regardless of circumstances, unless the insurance company goes bankrupt.

11. 32-day Notice Accounts/Call Deposits

Money invested at a fixed rate, allowing withdrawals with 32 days' notice.

Risk: Low risk; interest is calculated on the daily balance. Interest rate may fluctuate with market conditions, increasing risk.

Deep Dive into Shares: Ordinary vs. Preference

Understanding the different types of shares is vital for comprehensive investment securities and financial planning.

Types of Shares and Their Rights

1. Ordinary Shares

• Receive dividends only when profit is made; higher profit usually means higher dividend.
• Shareholders are the last to be paid if the company is liquidated.
• Dividends vary yearly and are determined by the company's board.
• Shareholders have the right to vote at the Annual General Meeting (AGM).

Rights of Ordinary Shareholders:

• Right to vote at the AGM.
• Right to attend the AGM to learn about company performance.
• Right to receive interim and annual reports.
• Claim on company assets upon bankruptcy, after all other creditors and preferential shareholders are paid.

2. Preference Shares

• Some types receive dividends regardless of profit.
• A fixed rate of return is paid.
• Have a preferred claim on company assets in case of bankruptcy/liquidation.
• Enjoy preferential rights to dividends/repayment over ordinary shares.
• Dividends are payable according to the type of preference share.
• Voting rights are restricted to particular circumstances/resolutions.

Rights of Preference Shareholders:

• Receive dividends regardless of profit.
• Receive a fixed rate of return/dividend.
• Paid first (preferential rights) on dividends.
• Preferred claim on company assets in event of bankruptcy/liquidation.
• Receive interim and annual reports.
• Voting rights only under particular circumstances/for certain resolutions.

Types of Preference Shares

• Participating Preference Shares: Guaranteed minimum fixed dividends and entitled to share in any surplus company profits, receiving higher dividends when the company performs well. Preferential rights over ordinary shares on repayment upon closure.
• Non-Participating Preference Shares/Ordinary Preference Shares: Receive initial investment plus accrued unpaid dividends upon liquidation. No right to participate in surplus profits; receive only a fixed rate of dividend.
• Cumulative Preference Shares: Compensated for past unpaid dividends when profits were too low.
• Non-Cumulative Preference Shares: Not compensated for past unpaid dividends.
• Redeemable Preference Shares: Can be bought back by the issuing company at a fixed price on a specified date/period.
• Non-Redeemable Preference Shares: Only bought back when the company closes for reasons other than bankruptcy.
• Convertible Preference Shares: Can be converted into a predetermined number of ordinary shares after a fixed period/on a specified date.
• Non-Convertible Preference Shares: Cannot be converted into ordinary shares.

Impact of Preference Shares

Positives:

• Proportional ownership in a company.
• Lower risk than ordinary shares due to preferential claims on assets at liquidation.
• Dividends paid out before other shareholders.
• Receive a fixed dividend amount/percentage per year.
• Cumulative shareholders may be compensated for past unpaid dividends.
• Shareholders may share in surplus profits (participating types).
• Limited liability to company debt.
• Receive claims on company assets after creditors but before ordinary shareholders during liquidation.

Negatives:

• No voting rights at the AGM.
• May receive less dividends when company profits are high, as dividends are fixed.
• Convertible shares may lose preferential rights if converted.
• Non-cumulative shareholders lose rights to past unpaid dividends.
• Risk remains if the company is liquidated.

Differences Between Ordinary and Preference Shares

Simple vs. Compound Interest: Understanding Growth

Distinguishing between simple and compound interest is fundamental for investment securities and financial planning.

Distinction Between Compound and Simple Interest

Calculating Simple and Compound Interest: An Example

Let's consider Ronnete, who wants to invest R30,000 for two years.

Scenario:

• Saints Bank offers 12% simple interest per annum.
• Caprica Bank offers 12% compound interest per annum.

1. Simple Interest (Saints Bank):

• Formula: Interest = P x R x T
• R30,000 x 12% x 2 years = R7,200

2. Compound Interest (Caprica Bank):

• Option 1 (Year-by-year):
• Year 1: R30,000 x 12% = R3,600
• Year 2: (R30,000 + R3,600) x 12% = R33,600 x 12% = R4,032
• Total Interest = R3,600 + R4,032 = R7,632
• Option 2 (Formula):
• Formula: P x (1 + r)^n
• R30,000 x (1 + 12/100)^2
• R30,000 x (1.12)^2 = R30,000 x 1.2544 = R37,632
• Total Interest = R37,632 - R30,000 = R7,632

Recommendation: Compound interest is the better investment option, as it yields a higher interest of R7,632, allowing Ronnete to earn interest on interest accrued.

Frequently Asked Questions about Investment Securities and Financial Planning

What are the main functions of the JSE in South Africa?

The JSE serves as a formal market for trading shares, linking investors with public companies. It acts as an economic indicator, informs investors on share prices, encourages participation from small investors, raises primary capital, and regulates the market for security dealings. It also provides investor protection and facilitates electronic trading.

How do I choose between different investment opportunities like unit trusts or fixed deposits?

Your choice should depend on your risk tolerance, investment period, and liquidity needs. Unit trusts offer diversification and professional management but come with market fluctuation risks. Fixed deposits offer guaranteed, stable returns but are less liquid and may yield lower returns over time. Consider your personal budget and the impact of inflation on each.

What is the primary difference between ordinary and preference shares?

The primary difference lies in their rights to dividends and company assets upon liquidation, as well as voting rights. Ordinary shareholders receive variable dividends based on profit and are paid last in liquidation, but typically have voting rights. Preference shareholders often receive fixed dividends and have preferential claims on assets and dividends, but usually have restricted voting rights.

Why is understanding compound interest important for financial planning?

Compound interest is crucial because it allows your investment to grow exponentially over time. By earning interest on your initial principal and on the accumulated interest from previous periods, your money works harder for you. This