Monday, May 14, 2012

Useful investment options

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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