Q&A with CMMB Securities

Q. I know mutual funds allow people to invest by putting aside a little money on a regular basis, but if I want to invest directly in the stock market is there any system that allows me to start with maybe $2,000 and then add a few hundred every month? 

Ravi, Cunupia  

A: Definitely, you can invest an initial amount in the stock market and then put in incremental amounts as you accumulate. In fact, this may be quite a good way of investing as it may result in something referred to as dollar cost averaging. This refers to the process of buying shares at different prices which, in a rising price environment, would result in an average cost for the portfolio which would be lower than the price that the share eventually increases to.  Therefore, even if you buy shares at a high price the overall average cost would be lower, resulting in an overall profit on the transactions undertaken. Some brokers may offer a facility where the funds may be housed in a money market account while the shares are being purchased.

In this way, the client is able to earn interest while the broker is sourcing the shares for purchase.  Some clients may even elect to set up a standing order with their bank to credit such an account every month with a fixed amount. They would then give instructions to the broker to invest these incremental amounts into shares mutually agreed upon or, in some cases, at the discretion of a portfolio manager in the brokerage firm. This is one of the advantages of stock market investing as opposed to other “equity type” investments such as real estate where very large amounts must be invested at one time. In the stock market, an investor with a much smaller amount can earn “equity-type” returns without having to accumulate large sums which they may not have or not in a position to borrow.  

Q. What is meant by capital appreciation? 

Tony, Cantaro  

A:There are two types of income which can be earned on a financial investment.  Firstly, interest income refers to that earned on a fixed income type of investment and would be a function of the rate on the investment and the time over which it is held. Therefore, the income earned on a fixed deposit held at a fixed rate of return for a fixed time period is referred to as interest. However, there are other types of income which can be earned on an investment. Capital appreciation is one of them. This refers to the increase in the value of the capital invested in the financial instrument.  For example, if one purchases 100 shares at $6 per share and over a month the price of the share increases to $7 per share, capital appreciation over that month is measured as the increase in value, which in this case is $1,000.

Similarly, if the price of the share fell to $5 the decrease in the value of the investment is $1,000 and is referred to as capital depreciation, the opposite of capital appreciation. The key difference between interest as opposed to capital appreciation is that interest is a function of the time held, whereas capital appreciation can occur irrespective of the time held and is impacted by a number of factors. These may include the level of interest rates, growth rate of the company, profitability and the cost of capital in the economy. Fixed income instruments are not impacted by these external variables and hence the returns are quite conservative. In equity-type instruments where there is room for capital appreciation (or its downside - depreciation) the returns are much higher as the risk arising from the impact of many variables is also much higher.  

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