By: Dr. Sunday Adache; Managing Director/ Principal Officer,
PKF corporate; Contact: admin.lesotho@pkf.com +266-22329799
FINANCIAL INVESTMENTS: THE SECRET TO SUSTAINABLE PASSIVE INCOME
“The kingdom of heaven is like a [very precious] treasure hidden in a field, which a man found and hid again; then in his joy he goes and sells all he has and buys that field [securing the treasure for himself].” Matthew 13: 44 (Amplified Bible)
Beginning our discussion from the wisdom of God, Jesus, teaching here that the kingdom of heaven is more precious than all of our earthly possessions put together. In the same vein to acquire a heaven on earth comfort and security for one’s earthly life, investment is key.
A financial investment is an asset (financial asset) that you put money into with the hope that it will grow or appreciate into a larger sum of money. The idea is that you can later sell it at a higher price or earn money on it while you own it.
CHARACTERISTICS OF FINANCIAL ASSETS
Investing in financial assets is an effective way to put your money to work and potentially build wealth. Smart investing may allow your money to outpace inflation and increase in value. The greater growth potential of investing is primarily due to the power of compounding and the risk-return trade-off.
On the other side, real investment, involves spending on tangible or intangible assets like property, machinery, or technology to enhance the productive capacity of a business.
A financial asset is a liquid asset whose value comes from a contractual claim, whereas a non-financial asset’s value is determined by its physical net worth. Non-financial assets cannot be traded, yet financial assets frequently are. The former, over time, will depreciate in value, whereas the latter does not.
There is another fundamental difference between the two that is most often ignored.
Financial investment is a scheme whereby the money works for the owner. It is much different from real investments where the investor is required to engage in a day to day physical activities of running the venture.
The acquisition of non-financial investments is tantamount to buying an employment for oneself. In the case of financial investment the maintenance required is basically review and decision making, which can be carried out in the comfort of your room. Or better still be assigned to professional investment management firms to act on behalf of the investor.
Hence the income from financial investment is part of the type of income termed a passive income, income with minimal efforts. The earning that is not determined by your level of activity but flows over time regardless of your sweat.
THE RATIONALES FOR FINANCIAL INVESTMENT
People generally expend most of their earning until they learn the habit or discipline of investing. The act of investing provides several benefits like:
- Wealth Accumulation: Investing allows you to grow your wealth over time by earning returns on your initial investment. Whether it’s through stocks, bonds, real estate, or other investment vehicles, putting your money to work can help it grow faster than if it were sitting idle.
- Meeting Financial Goals: Investing can help you achieve financial goals such as buying a home, funding your children’s education, or retiring comfortably and early. By putting your money into investments that align with your goals and time horizon, you can work towards achieving them more effectively.
- Beating Inflation: Keeping your money in a savings account or under the mattress may not keep pace with inflation. Investing provides the opportunity to earn returns that outpace inflation, preserving the purchasing power of your money over the long term.
- Retirement Planning: Investing in retirement accounts or pension plans can help you build a good money for retirement. Starting early and consistently contributing to retirement accounts can help ensure a comfortable retirement lifestyle.
- Risk Diversification: Investing allows you to spread your risk across different assets, industries, and regions. This diversification can help to reduce the impact of volatility in any single investment and improve the overall risk-adjusted returns of your portfolio.
- Compounded Passive income: Certain investments, such as dividend-paying stocks, rental properties, or bonds, can provide a steady stream of income. This passive income can supplement your salary and provide financial stability.
- Building wealth for future generations: Investing can create a legacy for your heirs by accumulating assets that can be passed down to future generations.
- Creating multiple streams of income: One of the best ways of establishing multiple income streams is investing in financial assets.
TYPES OF INVESTABLE FINANCIAL ASSETS
We have multiple options where to invest our money. Depending on the amount of capital, expected return and risk tolerance level, the alternative options or a combination of investment may be any of the following:
1. Savings Accounts & Term deposits: It is the easiest and convenient type of investment. The Bank offers interest on the amount deposited by their customers.
2. Government Bonds: Bonds are debt securities issued by governments, municipalities, or corporations to raise capital. When an investor buys a bond, they are essentially lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity. Bonds generally offer fixed interest rates.
3. Real Estate: Real estate investment involves purchasing property (such as residential, commercial, or industrial) with the expectation of generating rental income and/or capital appreciation. Real estate can provide stable returns and serve as a hedge against inflation but requires significant capital and entails ongoing management and maintenance costs.
4. Stocks/Shares of Companies: Stocks represent ownership in a company. Investors buy shares of stock, which entitle them to a portion of the company’s profits (dividends) and voting rights in shareholder meetings. Stock prices fluctuate based on company performance, market conditions, and investor sentiment.
5. Mutual Funds: Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. They are managed by professional fund managers, who make investment decisions on behalf of the investors. Mutual funds offer diversification and professional management, but investors should be aware of fees and expenses associated with them.
6. Exchange Traded Fund (ETF): ETFs are similar to mutual funds but trade on stock exchanges like individual stocks. They typically track a specific index or sector and offer diversification, flexibility, and lower expenses compared to many mutual funds.
7. Commodities: Commodities are physical goods such as gold, oil, agricultural products, or precious metals. Investors can buy commodities directly or invest indirectly through commodity futures contracts or exchange-traded funds (ETFs). Commodities can provide diversification and serve as a hedge against inflation and currency fluctuations.
8. Options & Derivatives: Options and derivatives are financial instruments derived from underlying assets such as stocks, bonds, or commodities. They allow investors to speculate on price movements, hedge against risks, or enhance returns through leverage. Options and derivatives is complex and carry very high levels of risk.
THE RISK-REWARD TRADEOFF
All investments involve a natural trade-off between risk and potential returns. Generally, assets with higher return potential also carry greater risk, while low-risk investments like Cash Deposits and Treasuries provide stable but modest returns.
In general, younger investors with longer time horizons can take on more risk, knowing they have time to recover from periodic downturns in volatile assets. Older investors nearing retirement may shift toward more low-risk securities to preserve capital.
Experts typically recommend a diversified portfolio containing a mix of low, moderate, and high-risk assets, tailored to your goals, timeline, and risk tolerance. Having some higher risk assets allows for growth potential, while maintaining a core of stable investments hedges against volatility. Meanwhile, a safety net of some low-risk investments can ensure you’ll be able to ride out rough episodes or generate needed income in older age.
BASIC TIPS TO FINANCIAL INVESTMENT PROCESS
Finally, it is prudent that before investing money, the following issues need to be considered:
- Assess the risk tolerance
- Check properly the cost of investment
- Set clear financial goals
- Invest in the correct time horizon to meet financial goals
- Engage professionals for guidance