FINANCIAL NOTEBOOK - Q&A with CMMB Securities

Q: You may have dealt with some of this before, but what is the basic difference between saving and investing, especially for a small income earner?
Darren, Carapichaima

A: The only difference between saving and investing is a matter of degree. In the local context, saving can be defined as a passive way of accumulating wealth whereas investing is a more active way of increasing the value of your money. Most people in Trinidad and Tobago tend to put what remains from their monthly salary, after expenditure, into a savings account at a commercial bank. The rates on these instruments have been traditionally much lower than other investment vehicles on the market. But lately, due to a general level of increased awareness in the market, individuals are becoming more open to new ways of making their money spin. They are now thinking more often of “investing” as opposed to merely “saving”. Investing involves a calculated construction of a financial portfolio composed of a variety of instruments suitable to the special needs and circumstances of the investor. A financial advisor, in building an investment portfolio, would look at a number of factors chief of which is the level of risk tolerance of the individual, which is indirectly related to the level of wealth the individual has already accumulated.

The time over which investments can be held is also critical and would determine the mix of suitable instruments. The probability of the individual needing the funds before the investment has matured is also pertinent and determines the portfolio allocation between different instruments. Finally the individual’s tax bracket must also be factored. In short, investing involves a holistic consideration of an individual’s goals, needs and circumstances all of which when combined with his or her risk tolerance can be factored into constructing an investment portfolio which seeks to optimise returns. This is markedly different from saving which is tantamount to merely parking funds on the lowest yielding instrument available without any consideration of other opportunities in the market.

Q : What are junk bonds?
Shirley, Tunapuna

A: A high yield, or “junk”, bond is a bond issued by a company that is considered to be a higher credit risk. The credit rating of a high yield bond is considered “speculative” grade or below “investment grade”. This means that the chance of default with high yield bonds is higher than for  other bonds. Before the 1980s, most junk bonds resulted from a decline in credit quality of former investment grade issuers. This was a result of a major change in business conditions, or the assumption of too much financial risk by the issuer. These issues were known as “fallen angels”. Their higher credit risk means that “junk” bond yields are higher than bonds of better credit quality. Generally, all bonds that are graded less than BBB are considered junk bonds. Junk bonds are issued by corporations or municipalities with bad credit ratings. In exchange for the risk of lending money to a bond issuer with bad credit, the issuer pays the investor a higher interest rate. Typically, junk bonds offer interest rates three to four percentage points higher than safer government issues. Above is a table showing the rating classes derived by Standard & Poor’s,  which gives an indication of the credit quality of issuers.

Q: I know people don’t like to think about it, but from a financial point of view are their any specific areas people need to be aware of when it comes to death (costs, what happens to investments, etc.)
Bharat, San Fernando

A: Estate planning is the process of creating a will or trust to pass on to your heirs after death. This is critical as it avoids the complications, which could arise if someone dies “intestate”, that is without instructions as to distribution of assets. In such a case there is a process called  probating where the State has to identify the heirs and apportion the shares according to their formula, which may not be in line with what you had intended.The process is expensive and time consuming and could well erode a portion of your estate in fees. Also even if you have a will, retitling would have to be done through a Court of law which is also time consuming. Therefore it is advisable to set up a will and a trust arrangement such that you have complete control of your assets while alive, but the trust is considered legal owner for transfer of title purposes.  This would take place smoothly without lawyers, court supervision, excessive costs or delays. You want to make sure your loved ones are protected and are given their just due according to your wishes. Talk to a qualified financial planner for further guidance, as this is a highly technical area where you would need advice.