A lowdown on low-risk investments

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It’s not just about returns, it’s also about risks

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Question:

What are the most common kinds of low-risk investments? — Alex Mendoza, BPO employee via e-mail

Answer: Allow me to give you a short but concise definition of investment first before I answer your query. “It is the commitment of funds made in expectation of returns. If the investment is properly undertaken, the return will be commensurate with the risk the investor assumes.”

I like that definition of investment—it’s not just about returns, it’s also about risks. If the investment is properly made, the risks determine the return and vice versa. Before anyone parts with his money, he should first understand the relationship of risk and return, which is very fundamental and which states that: Low risk=low return, high risk=high return.

The fundamental truth about risks and returns will not change. No amount of financial engineering will alter the fact that returns will always be a function of risks. Also, to say “low risks” does not mean “no risk.” I refuse to believe there is any investment instrument that can be categorized as no risk at all. Recent developments made the world realize that “no-risk” instruments like debt even of first world countries are not really “no risk” at all, in fact many even question if they really are “low-risk.”

Low-interest investments are mostly debt instruments such as savings, time deposits, special deposit accounts, treasury bills and notes, corporate papers and corporate bonds. The most common financial investments being transacted in the Philippines are debt securities, also known as creditor claims. In essence, one lends and another borrows for these types of transactions.

The simplest and most common form of debt instruments are savings and time deposits. A depositor gives money to a bank and the bank guarantees that the money is there after a stipulated period of time. In return, the bank pays the depositor for the use of the money for operations (lending, treasury and others). Since these instruments carry the guarantee of the bank and most of these are very short-term in nature and are highly liquid instruments (cash or near cash), the interest one gets from these transaction are really low.

The risk of the said investments are really low and if the bank is reputable and stable, the risk of capital loss is minimal and none at all if the amount is covered by PDIC (up to P500,000). The stability of the bank largely dictates the amount of interest it can give so the bigger/stronger the bank is, the lower the interest you can get. Smaller banks need to compete with the bigger and more reputable banks so they need to entice depositors with higher returns. This is a clear example of risk and return. However, investments in these instruments are relatively safe.

Further, the Bangko Sentral ng Pilipinas ensures that banks are solvent and must meet all its obligations through reserve requirements and other regulatory measures. Unfortunately, even good systems can be flawed and quite a number of ailing banks slip away from the central bank’s watchful eye. For savings, the market rates ranges from 0.5 to 0.8 percent a year and about 1 to 2 percent per year for time deposits. Smaller banks like commercial banks and rural banks offer higher rates of 2 to 5 percent per year.

Low-risk investments, especially savings and time deposits, are not functionally low risk if you take inflation in consideration. The yields of these low risk investments are always below inflation rates. This means that in time, the real value of your investment will diminish. After all, the value of money is not based on its amount but rather on what it can buy. Keep your emergency funds and the money that you need for one year in the form of savings and time deposits, anything beyond that should be invested elsewhere.

Learn more on investing by attending the biggest investment conference of the year, iCon 2014, on May 17, 2014 at the SMX. For more details, visit www.brandspeakasia.com/icon

tiongson_inqRandell Tiongson is a Registered Financial Planner of RFP Philippines. He is one of the most sought after speakers in Personal Finance and Columnist of Philippine Daily Inquirer and Money Sense Magazine. He is best selling book author of Personal Finance Step-by-Step Guide.

Source: http://business.inquirer.net/165933/a-lowdown-on-low-risk-investments

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