In my blog titled ‘simple investment tips’, I explained that after you have gained sufficient knowledge on
investment strategies and determined your risk taking capability based on your
investment goals, various investment options are available in the market on
basis of these goals. One of the options I mentioned is investing for safety
(high liquidity) – like bank deposits, money market mutual funds etc. They are
also referred to as short term
investment options because of their duration which can range between a day
and 12 months.
Here I will discuss briefly investment for safety options with slight
elaboration:
1. Bank savings account
This investment
option is the most common form of investment option. It is used only for
short-term (less than 30 days) surpluses. This investment option is often the
first option people use for investment. , savings accounts offer low interest
(2.5%-4% p.a.), making them only marginally better than closely comparable
options like safe deposit lockers.
A bank savings
account is a type of account designed to simply hold money that you do not need
immediate access to. When contrasted with checking accounts, bank savings accounts
tend to pay a slightly higher rate.
Savings accounts
offer easy access to your cash. In other words, your money is liquid (meaning
you can make a withdrawal easily and quickly) in a bank savings account.
Bank savings accounts grow your money. When
you have money in a bank savings account, your money earns interest. This is a
nice feature. Your bank savings account pays a rate of return on all the money
in the account (your Annual Percentage Yield). That means that you get
"paid" for keeping your money in the account. If you were not going
to use the money anyway, then getting paid a little is better than nothing.
Think about saving £1
per day for thirty days. This will amount to £30 per month. If you save £30
that you do don’t have to spend for another twelve months, which will give you
£360 per year without interest. Assuming the bank decides to pay 2.5% per annum
(i.e for 12 months) on your savings, your £360 would have earned additional
2.5% interest compounded either daily, weekly or monthly. I will explain this
in details in my next blog. The bottom line is when you put your money in banks
savings account; your money earns interest which is the opportunity cost of
putting it into another use elsewhere.
2. Money market funds
According to Ivestopedia , Money Market Funds is ‘an investment fund that holds the objective to earn
interest for shareholders while maintaining a net asset value (NAV) of $1 per
share. Mutual funds, brokerage firms and banks offer these funds. Portfolios
are comprised of short-term (less than one year) securities representing
high-quality, liquid debt and monetary instruments. They explain that its purpose
is to provide investors with a safe place to invest easily accessible
cash-equivalent assets characterized as a low-risk, low-return investment.
Similar to your bank
savings deposit, money market funds take your money and invest it. Then, they
pay a portion of their earnings to you in the form of dividends. Money market
funds usually pay a monthly dividend, but there are some alternatives out
there.
This investment
option offer better returns than savings account without compromising
liquidity. Money market funds are a specialized form of mutual funds that
invest in extremely short-term fixed income instruments such as Treasury Bills and Commercial papers. Unlike most mutual funds, money market funds are
primarily oriented towards protecting your capital and then, aim to maximize
returns.
Money market funds
usually yield better returns than savings accounts, but lower than bank fixed
deposits. There is no investment without risks therefore this investment
options come with some. These include:
- The fund is a form of
security. There is no guarantee that that the share price will stay at
amount quoted per share although fund managers attempt to keep the price
constant. High risks mean that the funds return high yield than banks
savings account.
- Money market fund rates are
variable. In other words, you don’t know how much you’ll earn on your
investment next month. The rate could go up or down. If it goes up, that
may be a good thing. However, if it goes down and you earn less than you
expected, you can end up needing more cash.
- Money market funds returns
can diminishes over time with inflation. Because money market funds are
considered to be safer than other investments like stocks, long term
average returns on money market funds tends to be less than long term
average returns on riskier investments. However, the strategy of the fund
is to invest on a short term basis.
The best place to
find out about a money market fund is the fund's prospectus. You should always
read one of these before buying any fund, and you can really learn a lot by
reading the prospectus from several different funds. For instance, free information on prospectuses and reports can be found here.
3. Bank fixed deposits
This investment
option is for investors with low risk appetite, best for 6-12 months investment
period. Also referred to as term deposits, this product would be offered by all
banks. Minimum investment period for bank Fixed Deposits (FDs) is 30 days. This
investment options shall be ideally used to the period of 6 to 12 months.
Normally interest on bank less than 6 months bank FDs is likely to be lower
than money market fund returns. It is important to plan your investment time
frame while investing in this instrument because early withdrawals typically
carry a penalty.
Term deposits are an
extremely safe investment and are therefore very appealing to conservative,
low-risk investors. By having the money tied up you'll generally get a higher
rate with a term deposit compared with a demand deposit.
What are the main features of Fixed Deposit
Account?
The main features of
fixed deposit account are as follows:-
- The main purpose of fixed
deposit account is to enable the individuals to earn a higher rate of
interest on their surplus funds (extra money).
- The amount can be deposited
only once. For further such deposits, separate accounts need to be opened.
- A high interest rate is paid
on fixed deposits. The rate of interest may vary as per amount, period and
from bank to bank.
- Withdrawals are not allowed.
However, in case of emergency, banks allow to close the fixed account
prior to maturity date. In such cases, the bank deducts 1% (deduction
percentage many vary) from the interest payable as on that date.
- The depositor is given a
fixed deposit receipt, which depositor has to produce at the time of
maturity. The deposit can be renewed for a further period.
As you keep in mind
the investment advice set out above, never invest capital required for your
survival. Invest only that money that you can afford to lose completely and seek advise from a professional financial advisor if you in doubt.
To your success.
Ayodele Ojo
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