Oran Hall, Personal Financial Adviser

Hall

QUESTION: PFA received queries from three young people recently. James is a 19-year-old college student who saves $800 each month, has five bank accounts, and wants to buy a good car and "other things" in five years. After working for two years, he is keen to invest, particularly in stocks, and solicits an opinion on fixed deposits.

Diana is a young university graduate with a disposable income of $25,000 per month and wants to purchase a home.

Kevin is a newly appointed pharmacist who plans to continue living with his family for the next year. He can invest $20,000 per month with a view to opening his own business in 10 to 15 years, has no interest in get-rich-quick schemes, and has an investment-type insurance policy with a monthly premium of $3,000.

PFA: What are the investment options available to these three who have different goals - car, house and business?

They fit into the early career stage of the life cycle approach to personal financial planning. This is the period of firsts - first job, first marriage, first child, and so on. This is the period of limited financial resources and low earning power when there is much to acquire.

Generally, the level of personal assets is more than investment assets. Savings are a priority, as is tax savings.

Starting to save early really allows the power of compounding to work. Investing for growth is desirable and there is usually sufficient time to recover from any setbacks. This is the beginning of the accumulation phase.

It is commendable that James, though a student, is saving. He has not said what kind of bank accounts he has or with how many institutions he has them though he gives the reason for having five as not wanting to put all his eggs into one basket. That is one way to diversify, thereby spreading his risks. But, the price he pays for that is the surrendering of the opportunity to get better rates on a larger pool.

That he desires to invest in equities suggests he recognises he can also diversify by investing in several types of securities.

Fixed deposit much better

Fixed deposits give a better return than savings accounts and generally give higher returns as the size of the deposit increases and as the term lengthens. Government of Jamaica repurchase agreements, money market unit trusts, and money market accounts tend, however, to give better returns.

Buying stocks is a good option for James but he must recognise that they will expose him to more risk than bank deposits and government securities, for example.

He must be prepared to do serious research, set targets, be patient, eschew being sentimental to any stock, and resist the temptation to time the market.

Although it is good to diversify, it is not advisable to spread his resources over too many stocks. Unit trusts and mutual funds that invest in stocks offer another option.

Diana does not indicate a timeframe for buying her house and should recognise that the National Housing Trust presents a real option for sourcing a low-cost mortgage, even if she must also borrow from another institution. Her first objective should be to secure her downpayment and closing costs.

Mixture of stocks

A mix of stocks and money market instruments would be helpful. Considering that stocks are not necessarily the most liquid investments, she should also consider investing in mutual funds or unit trusts to give her liquidity and diversification.

The risk is real that prices of equities and associated unit-trust investments may be depressed at the time she needs the funds. With proper guidance, she could also invest in foreign-denominated securities to hedge against the decline of the local currency.

Kevin's long-term investment horizon makes it easier to realise tax savings for, apart from that derived from stock and funds that invest in them, he can also earn tax-free income from qualified interest-bearing accounts if he holds them for five years, does not withdraw principal prematurely, and withdraws no more than 75 per cent of the interest earned in any period.

The most he can invest in any year in these accounts is $1 million.

Although compounding can work very well for him, Kevin needs to hedge against inflation by investing for growth. Stocks are good for that. Like Diana, he needs to hedge against the devaluation of the Jamaican currency.

All should seek the guidance of at least two reputable investment dealers to decide how to proceed.

Oran Hall offers free personal financial advice and counsel. Email: finplan@cwjamaica.com