- Short term Investments
Investments can be divided into long term and short term ones. In this posting we discuss the short term investments. These are based on exploiting the concept of compound interest to increase the value of your wealth. They are meant to generate cash resources to fund short term expenses. Generally it is these which should be used to pay for consumptive expenses. They fund purchase of heavy cost expenses e.g. school fees and household goods and cut off debt. These are mostly money market portfolio that can be used to store short and intermediate savings. Most people would save their money with banking savings account which generally have more bank charges than interest. The interest rates for these are too low. However if one was to use a money market investment they can generally get better interest which are higher than the bank charges and therefore one’s money actually grows.
Remember that: Debt is compound interest working against you while money market investments allow compound interest to work for you.
“Those who understand compound interest are destined to collect it. Those who don’t are doomed to pay it.” Tom and David Gardner of “The Motley Fools”
Money Market- simply means one is lending money to gain interest from various players. Bankers call it buying bonds/bills etc. When you lend money to the banks its called certificate of deposits, when you lend money to the government its called treasury bills. When the money is lent to corporate its called bankers acceptance or BAs. Please note that you do not personally approach the person you are lending too but you approach the banks who then structure these instruments for you. BAS tend to have a higher interest rate than TBs and Municipal bonds because of the perceived risks. Treasury bills can be considered very safe as the risk of default or failure to pay is minimal. However in some countries in Central America governments have failed to honour their payments and so this is not virtually risk free. TBs can be risky due to political instability and currency risk. However in Zimbabwe right now due to the use of hard currency, the exchange rate risk does not exist.
People generally buy money market investments also known as bills for two primary reasons namely:
- These pay investors a fixed interest rate payment regularly or if its too short term at end of the term. So they invest for the income.
- There is a definite return of the principal investment amount at the end of the investment term. Please note that this investment amount does not have capital appreciation or growth apart from just the interest earnings.
These investments are generally safe investments because you know upfront the kind of return or interest that you get as well as when you have the funds back. These instruments in the short term are less volatile and less risky as compared to stocks.
So one can actually set a date for the return of funds in alignment with one’s intended uses. The things you need to know about the money market investments are:
l How much interest or return do you get?
l How safe is your money both capital and interest? E.g default risk
l When do you get your money back? Maturity date.
Another form of money market instruments are the Mutual Funds or Unit Trusts. These are investments in units of equity but generally they underperform and I therefore do not recommend them. Many people have been hurt because the unit trust did not produce the anticipated returns especially in Zimbabwe. A current controversy is that some unit trust managers zeroes investment made by people due to the dollarization when infact the investments were holding stock exchange listed assets which simply converted to USD. So these should still have some residual value based on the equities that the Funds hold. Yes the Fund may have dipped due to the poor performance of the ZSE but still the underlying investment is already in USD therefore people should not have lost their value.
The other reason why I do not appreciate unit trusts is that they are too dependent on the fund manager who can lose value by trading too much on the account. You also cannot be sure how much of your finds are being invested as most Fund Managers in Zimbabwe will start by deducting their management charges and fees prior to investment. So you are not sure how much exactly has been invested.
The beauty of money market investments is that you can earn interest on your funds while waiting to spend them. They are useful as well for emergency situations. Because they can generally be liquidated easily. They also help prevent a situation where someone is “asset rich but cash poor” i.e. the person has real wealth fixed in long term assets but has no cash to fund lifestyle expenses or emergency situations. It is critical to have a portion of one’s portfolio within this category for the above reasons.
I encourage anyone who is keen on investing to have a chat with his bankers to understand how they can access money market investments.