Q&A with CMMB Securities

Q. The word equity comes up a lot in the business press, but what does it mean in terms of investments?

Kevin, Lopinot

A: Financial instruments can be classified into two categories, fixed income and equities. Fixed income instruments are those which generally offer principal protection (protection of the funds you invest) and a fixed rate of return. Equity investments, such as stocks, do not provide principal protection, but the potential return is much higher than fixed income instruments, albeit more volatile. There is another context in which the word equity is used in the financial arena. Equity in a business refers to the capital which is put up by shareholders to start the business as opposed to debt, which is the amount borrowed from the bank to finance the business. When investing in the stock market some analysts may refer to the level of equity in the business in comparison to debt. Generally, the higher the level of shareholder capital or equity in a company, the lower is the risk for an investor buying shares in that company, all things remaining constant. The ratio of debt to equity is referred to as the level of “gearing” in the company. So, if your stockbroker says that the company has a low level of gearing he or she simply means that there is a higher degree of equity as opposed to loan capital, which reduces the risk of investment.

Q. I hear people talk about financial independence all the time, even the politicians are now using the expression, but what does it really mean? Almost everyone in the country seems to be living on credit.

Lisa, St. Joseph

A: Financial independence is an elusive concept indeed. But is not unrealisable. Once a savings and investment ethic is developed from early, over time the goal of financial stability can be achieved. The process is simple. The higher the return required, the higher is the risk that would have to be taken. That’s the bad news. The good news is that risk is reduced the longer the time over which the investment is held. Therefore younger folks, with say ten or fifteen years to retirement would want to invest a larger percentage of their funds in the stock market, which, although volatile in the short-term, can generate significant wealth over the long term. The stock market is an avenue through which you can build wealth over time.  The problem in Trinidad & Tobago is that the older generations were taught that savings only meant a savings account at the bank. They therefore lost the opportunity to start investing in the stock market early. If they had done that, over the past ten years they would have earned an average rate of 20% per year.

Think about it, if you had $50,000 ten years ago you would now have just over $300,000 today from leaving your funds in the stock market. On the other hand, leaving it in a savings account in the bank would have increased your $50,000 to $75,000, calculated at an average rate of 5% per annum. We in Trinidad & Tobago need to look to the stock exchange and develop that culture in our youth. In the United States over 30% of households own stock. We need to increase the percentage in Trinidad & Tobago. That will definitely help the process of developing financial independence.

Q. My VSEP package will be coming through soon and after taking care of some matters I should have around $5,000 to save or invest. What’s the major difference between putting the funds in a money market account compared to trying the stock market?

Anand, Couva

A: The main difference between a money market account and the stock market is the degree of risk taken. A money market fund offers principal protection against the assets of the fund. For example, most of the money market funds in Trinidad & Tobago have a predominant holding of Government securities. An investor getting into the fund is essentially buying Government assets. Therefore, by extension, the obligation of the investment is secured against the Consolidated Fund of Trinidad & Tobago from where the Government services debt. In the stock market the investment is unsecured and the investor is taking the risk of the company as opposed to a money market account where the investor is taking, to a large extent, the risk of the Government of Trinidad & Tobago, which is extremely low. In fact such an investment is loosely referred to as a risk-free investment.

Due to the difference in risk between the two types of investments the possible return on the stock exchange is therefore higher than a money market account as the risk taken is much greater. In fact, the return on capital invested in shares is extremely lucrative and exceeds returns on investments made by entrepreneurs in certain types of businesses. Therefore it may be better, from an economic point of view, for some persons with capital who are contemplating embarking on a business to invest in the stock market rather than opening their own businesses.

Questions can be sent to PO Box : 1830, Wrightson Road, Port-of-Spain
E-mail : cmmbsecuritie@mycmmb.com