Q&A with CMMB Securities

Q. You spoke about annuities last week. Are annuities only used for retirement savings or can they also be a good long-term investment choice?

Norman, St James

A: An annuity serves the dual purpose of being a retirement vehicle as well as a long-term investment instrument. Specifically, (as noted last week) its value as a long-term asset is derived from the tax break on contributions up to $12,000 per annum. Remember, apart from considering the return objective, risk tolerance and investment horizon of an investment, the degree of tax efficiency derived from investing is also a primary consideration.

Apart from the tax benefit the return derived on these investments is also quite attractive when compared to other instruments, especially in a low interest rate environment. Also, the fact that it cannot be broken before an eight-year period without losing the tax benefit imposes a savings discipline on investors. Furthermore, if the cash value from an annuity is to be used as a downpayment towards a new home the money can be withdrawn before the eight-year period without losing the tax benefit. In short, an annuity gives the investor a rich, tax-efficient return with low risk while still maintaining flexibility.

Q. I’ve heard the term arbitrage used in connection with stock markets, what does it mean?

Vinod, Arouca

A: Arbitrage refers to the buying of a good in one market and selling the same good at a higher price in another market. In terms of stock markets, shares in some markets, due to a host of different factors particular to that market, may trade at different price levels in another market. This generates a disparity between what stocks trade at in the relevant markets. This price differential presents arbitrage opportunities to investors. Put another way, arbitrage is: The buying of foreign exchange, securities or commodities in one market and the simultaneous selling in another market. By this series of actions a profit is made because of the difference in the rates of foreign exchange or in the prices of securities or commodities involved.

Q. In your column you have explained different types of stocks, but what are growth stocks? I would have thought you would want all stocks to grow.

Gloria, Point Lisas

A: A growth stock is typically defined as one that has experienced, or is expected to experience, rapidly increasing earnings per share, and by extension, price appreciation. It is often characterised as having high Price/Earnings and Market/Book multiples. Typical grow stocks would be those whose issuing company is in a growth industry, technology stocks for example. On the other side of the coin, value stocks are those that have experienced relatively poor price appreciation, or whose company’s earnings are not expected to grow substantially. Companies in this category would include utilities and other firms operating in mature industries.