Investment is undoubtedly the best way to wealth-creation. The returns on investment are what drive people into investing. It is good to see your money grow when you invest, but you should be wary of the kind of investment you invest in. Most often, people get excited about the returns they are likely to earn on the investment, and hence may forget to check if they are taking on some risks that might result in them losing their hard-earned income.
An investment expert once said: “The return on investment is important, but return of the investment is critical!” Investments in financial assets and other alternative investments have guiding principles that can help the investors to minimise their risks and make optimal returns on their investments.
Investment risk can be defined as the probability or likelihood of losses occurring relative to the expected return on any particular investment. Stated simply, it is a measure of the level of uncertainty in achieving the returns as per expectations of the investor. Assets carry varying levels of risk.
For example, holding a corporate bond is generally less risky than holding a stock. Government bonds are generally not considered risky assets. You need to invest, but you have to invest right.
This article seeks to discuss some pointers on how an investor can spot a risky investment.
How to know you are putting your money in a risky investment
- When the product is too complex
There are investment products whose features are complex, and it is difficult explaining them to investors. The more the complexity of an investment product, the higher the probability of loopholes in it being exploited to the investor’s disadvantage.
In recent times, Ghana has had some Ponzi schemes feature on the market whose product features were very complex. Though they gave some investors good returns, typical of a Ponzi scheme, those who invested at the latter part could not retrieve their investments upon request. This has led to law-suits, demonstrations, and pleas to government for intervention in them retrieving their funds. Please understand that any investment with too-complex features is risky to a large extent.
- When the return on investment is supernormal
Reports on some collapsed microfinance, savings and loans institutions, investment houses and banks in the just-ended financial sector clean-up exercise revealed that most of those market players offered their investors supernormal returns. For instance, those who had fixed deposits with tenor ranging between 91-day and 364-day bills were being offered returns far above Treasury bill rates of the same tenor.
The extra premium far above Treasury bill rate is the risk you are taking with your money. Ask yourself: what kind of investment instruments are they investing in on the market to churn out such supernormal returns? Do you know that some of the collapsed firms were actually offering those high returns to cover up their liquidity problems?
They know if they quoted a high rate on your investment for you, your attention would be shifted to the returns and you would not make demands on them for withdrawals or redemptions. Beware! If the interest rate is too good to be true, then it may be risky. Watch out!
- When the company is not licenced
In all the categories of investors who lost their funds in the recent financial sector clean-up exercise, the investors whose losses were most severe were those who invested with companies that were not licenced. In such an instance, who do you go to for redress?
In Ghana, the two main regulators of the financial services industry are the Bank of Ghana and Securities and Exchange Commission. The Bank of Ghana regulates banks, savings and loans companies, forex bureaux and microfinance institutions. The Securities and Exchange Commission regulates investment banking firms, brokerage houses, asset management companies, etc.
Other regulators include the National Pensions Regulatory Authority, the regulator of players in the pensions industry. Pension Fund Trustees, Pension Fund Managers and Custodians fall within its purview. The National Insurance Commission is the regulator for all insurance companies in Ghana, while the Apex Bank is regulator of Rural Banks in Ghana. Now that you know who the regulators are, you need to establish whether or not your investment house of choice is licenced; and if it is, is it in good standing?
So, placing your hard-earned funds with an unlicenced firm will only lead to regret.
Some facts on risk and return in investments
- The relationship between investment risk and return is proportional. Hence the saying, the higher the risk, the higher the return; the lower the risk, the lower the return.
- When an investment vehicle offers a high rate of return in a short period of time, that investment vehicle is likely to be risky.
- Given enough time, many investments have the potential to double the initial principal amount; but many investors are instead attracted to the lure of high yields in short periods of time despite the possibility of unattractive losses.
- There is no guaranteed way to double your money with any investment, but there is a plethora of investment examples that doubled or more in a short period of time. For every one of these, there are hundreds that have failed. So, the onus is on the buyer to beware.
- Finding an investment that enables you to double your money within a year is almost impossible, and will certainly involve taking on risks.
- However, there are some investments that might not double your money but do offer the potential for big returns; as they are based on fundamentals, strategy and technical research.
Given recent happenings in the banking and finance sector in Ghana, it is not enough investing toward retirement. You need to avoid placing your hard-earned funds in risky investment schemes that could lead to regret. Investment is highly recommended, but you need to invest right. It is good to invest, but do so cautiously to ensure you don’t lose your funds to a reckless investment service provider. As an investor, you need to invest only with licenced investment service providers; you need to constantly check the return they are promising to see if it is reasonably comparable to government securities with similar tenors.
An investor needs to ensure that the product they are buying into is not too complex and they fully understand what they are putting their monies into. Investors should cultivate the habit of reading, listening to business news, going to annual general meetings and asking questions.
Doing all these will help you take calculated risks and earn for yourself returns that will reward you for postponing your consumption. The time for passive investment is long gone; modern-day investors should be curious enough to research their investments, or pay others with the expertise to do so on their behalf. Every investor owes this as a duty to himself or herself.
By Sophia Kafui
The writer is author of the under-listed books:
- Start Right: A Guide to Financial Investments in Ghana
- Overcoming Infertility: What to do When Childbirth Delays
- Contemporary Parenting
- Stepping up Your Life
Email Address: firstname.lastname@example.org
Disclaimer: Views expressed in this article are the personal views of the author and do not reflect the views of the organisation she works for.