Q&A with CMMB Securities

Q.   I’ve been looking at the price of oil and it seems to be going up and down in quite an unpredictable fashion. What are the reasons for this?

Mervyn, La Romain

A: The price of oil has been quite volatile over the past few weeks due to shifting expectations about the war in Iraq. In the weeks leading up to the war the price started to increase significantly, going over the US$30 level. This was due to fears of possible oil shortages given that Iraq is the seventh largest exporter of oil in the world. However, when the bombing campaign started, the price fell drastically down to US$24 contrary to what most had expected. This was due to a number of variables.

Firstly, the markets were expecting that the war would be short given the initial successes of the US led forces and rumours that Saddam Hussein may have been killed. Secondly, OPEC producers promised to increase quotas to allay some of the fears which had been developing. Thirdly, news that America had a substantial six billion barrels of oil in its Strategic Petroleum reserve calmed some of the fears of a supply shortage. However, as time passed and news came out about casualties, prisoners of war and a possibly protracted engagement in Iraq, the price once again rallied above the US$30 level factoring declining supply.  So we see that when there is uncertainty in the market, prices tend to be erratic. Investors tend to be undecided as once news is released which changes expectations, the price of oil would quickly react to it, causing the frequent oscillations which we have been witnessing in recent times.

Q.   I retired two years ago with what I thought was a nice little nest egg.  But I’m surprised at the speed at which it’s getting eaten up. Is there some sort of formula I can use to work out a spending plan that will not wipe out my savings?

Doreen, Sangre Grande

A: There is no magic formula to this, just plain old fashioned budgeting. Since you are no longer working your income would obviously be substantially reduced and so you need to reprioritize your expenditure. Start with a list of what is absolutely essential and calculate the total cost per month. Then determine what rate of return on your nest egg would give a monthly flow that covers your necessities 1.67 times.

In other words your necessities should not exceed 60 percent of the monthly return on your nest egg. Of the remaining 40 percent, half could be put into a rainy day fund in case of emergencies. The other half should be put towards insurances, which I assume you already have and which you have to continue to pay.  It is extremely important to not let insurances lapse since they would be a source of funds in case of illness. Such circumstances can put a strain on your nest egg if you do not have insurance cover.

The emergency fund should be built up and kept at three times your monthly necessity expenditure. If it goes over that level you could then use those funds for discretionary expenditure, such as a special vacation, luxury items, etc.  Remember, the allocations to emergency and insurances should be mandatory. Therefore what you classify as necessities must be able to fit within the 60 percent of your monthly investment income. Some adjustment to your lifestyle may be necessary, as you should only invest in fixed income instruments with built in principal protection. The rates on such investments are conservative and may not be able to cover what you classified as necessities before you retired. However, talk to a qualified financial planner, as you may be able to invest in instruments whose yields increase as interest rates rise.

Q.   I’ve read your comments about the dangers of having debts you can’t meet. I have a small business and instead of taking out a loan to buy equipment, I am considering leasing the machinery I need. Are there any pitfalls to leasing?

Vashti, Siparia.

A: The business strategies you adopt must be relative to your particular situation. Leasing can be extremely helpful, especially when a business needs to expand output temporarily, for example for a special contract awarded. In such a situation you would not want to buy equipment as you may end up with idle capacity after the contract. The lease would allow you usage of equipment just until it is required. It is also good as equipment can become obsolete by changes in technology and you would want to be flexible to change the type of equipment you use.

However, it is important to understand the terms and conditions between the lessor and the lessee. Some leases require that the lessee maintain the equipment and pay for non-warranty repairs for the duration of the lease, in which case it increases the cost of using the equipment especially if it has been used a lot. The cost of financing a lease (the lease payments per month) can also be extremely expensive when compared to the monthly loan installment on equipment purchased. It may also be very difficult to get out of a lease before the scheduled date without incurring stiff penalties. This may reduce some of the flexibility we spoke about if you have to shift your business strategy quickly. Some businesses may reverse the situation in that they may buy a piece of equipment and if later on there is idle capacity the equipment can then be leased out to another business to cover the loan installments.

Questions can be sent to
PO Box 1830, Wrightson Road, Port-of-Spain.
Or email: cmmbsecurities@mycmmb.com