Connect with us
nairametrics
UBA ads

Editors Pick

How to choose between investing in bond funds, money market funds or savings bonds

How to choose between investing in bond funds, money market funds or savings bonds

Published

on

Photo by Steve Johnson on Unsplash, bond funds, money market

Following the monthly issuance of FGN savings bond by the government as a means to make the Nigerian bond market accessible to retail investors, a lot of people have been asking whether to invest in such savings bonds or to invest in money market or bond funds instead.

That question of choice of investment type is not out of place. One of the processes of investment, having determined one’s risk tolerance and investment time horizon, is to decide on asset allocation. Asset allocation decision entails choosing between different available investment types or a combination thereof.

UBA ADS

So, this question falls within the ambit of asset allocation decision making. To be able to choose, one needs to know what each of the available asset classes or investment types are and what their characteristics are. You would not want to choose the unknown, which will be akin to shooting in the dark. So, the first step is a good understanding of the investment types, their features and what they offer both in terms of risk and returns.

A bond, and in this case, a savings bond is a debt obligation, like an IOU, issued by an entity, in this case, the federal government. When you buy the FGN savings bond, you are lending money to the government in return for a piece of paper, an IOU, that acknowledges that you have lent the government a specified amount for a specified period.

In exchange for the loan, the federal government will pay you interest at stated intervals, usually every three months, and at maturity, you will receive the amount you lent to the government back. The interest payment incidental to a bond is contractual and obligatory on the borrower, (the government) and non-payment constitutes an enforceable or actionable breach of contract that could even lead to bankruptcy, in extreme cases.

GTBank 728 x 90

[Read Also: See two key factors that can affect the value of your assets]

On the other hand, a bond fund is a mutual fund that invests in bonds. When you invest in bond funds, you are indirectly invested in the bonds that make up the basket called XYZ bond fund. When you invest in a savings bond, for example, you are most likely going to invest in just one or two of such bonds, but when you invest in a bond fund, you are invested in all the bonds that make up the bond fund, and that is where diversification comes into play. Should you want to invest in as many bonds as contained in a bond fund, you will need to invest lots of money.

Money market funds are like bond funds, only that they invest in short term fixed income securities like treasury bills, commercial papers or even savings bonds. Again, you are not investing directly in the constituent investments, but indirectly through the money market fund.

When you invest in a bond, or savings bond, you are almost guaranteed that you will receive your principal back at maturity as long as you hold it to maturity, unless the issuer defaults through bankruptcy. That is the credit risk characteristic of a bond. Since it is FGN savings bond, the probability of default is very remote.

Investment in a bond fund or money market fund does not guarantee a fixed interest payment, rather, the interest fluctuates according to market conditions which have an effect on the performance of the bond fund.

Again, the prices of bond funds are based on the prices of the underlying bonds contained in the basket, such that, if prices of the bonds fall, the Net Asset Value (NAV) of the bond fund will also fall. In that case, you may lose part or all your principal investment in the bond fund, depending on the extent of decline in prices.

app

This, therefore, means that bond funds and money market funds carry more risk than direct savings bond investment. The other side of the coin is that when you invest in bond funds, you have the opportunity to receive much more than your principal investment if prices keep going up and the fund’s NAV is on the increase. That upside potential is the compensation for the additional risk taken by investing in bond funds.

[Read Also: Nigeria’s Mutual Fund asset value may reach N1tn before December 2019]

Which Type should you Invest In?

There is no absolute answer to the quest as it depends on some factors that are investor specific. The major determinant of which one to buy or invest in should be your risk tolerance profile, investment time horizon, and the amount of money available to you.

devland
Coronation ads

If you are willing to bear the added risk, then bond mutual funds might be a better choice especially if you expect the interest rate to decline within your investment time horizon. This is because bond prices increase when interest rates fall.

In that case, bond funds’ NAV rise when interest rates fall thereby giving the bond fund investor more capital gain or capital appreciation. But unfortunately, that gain could be eroded if interest rates begin to go up because at that point in time, bond prices will fall and so will the resulting NAV from bond funds.

GTBank 728 x 90
thegreenafricaproject 300x250

What this implies is that, if you expect interest rate to rise, it will be better to buy savings bonds or invest in money market funds rather than bond mutual funds whose prices fall with rising interest rate. By so doing, you will enjoy the regular interest payment on bonds and be sure to receive your principal from the government at maturity.

Diversification is the Key

Depending on your investable funds, the best bet is to diversify by splitting your investment between FGN savings bonds, money market mutual funds and bond funds so that you hedge against falling and rising interest rates or other economic circumstances and end up having the best of both worlds.

 

Patricia

Uchenna Ndimele is the President of Quantitative Financial Analytics Ltd. MutualfundsAfrica.com and mutualfundsnigeria.com (both Quantitative Financial Analytics company website) is a leader in supplying mutual fund information, analysis, and commentary on African mutual funds. We provide reliable fund data; and ratings information that will add value to fund managers, the media, individual investors and investment clubs.

2 Comments

2 Comments

  1. Yemi Akindele

    June 19, 2018 at 5:27 am

    Thanks so much. It’s very educative.

  2. Anonymous

    June 24, 2018 at 9:21 am

    This is fantastic fast track to education in bonds investment.You also keep it simple to understand.
    Thanks
    Abdul

Leave a Reply

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Currencies

DEVALUATION: CBN updates website to official rate of N360/$1

The central bank of Nigeria has devalued its official exchange rate from N307/$1 to N360/$1.

Published

on

CBN website states oil price is still $61, Naira under pressure as Nigeria records poor export earnings, 4 key sectors the CBN plans to pump money into

Just as Nairametrics reported, the Central Bank of Nigeria has devalued its official exchange rate from N307/$1 to N360/$1. The apex bank has now reflected this change on its website signaling a confirmation. The bank is yet to issue a press release to this effect.

The CBN has now officially devalued by 15% moving from N307/$1 to N360/$1. Depreciation at the “market-determined” I&E window is 5% having moved from N360/$1 to N380/$1

UBA ADS

Devaluation: Nairametrics reported yesterday that the Central Bank of Nigeria (CBN) sold dollars to banks at N380/$1 in a move signifying a devaluation of the currency. Banks trading at the Investor and Exporter (I&E) window bought dollars at N360/$1 from the CBN on Friday, March 20, 2020. The I&E window is the official market where forex is traded between banks, the CBN, foreign investors, and businesses. The central bank typically buys or sells in the market as part of its intervention program.

The CBN has updated its website with the official exchange rate.

Nairametrics also got hold of a letter from the CBN to banks informing them of the new exchange rate for dollars flowing from the International Money Transfer Operators (IMTOs). According to the CBN, IMTOs will sell to banks at N376/$1 while banks will sell to the CBN at N377/$1. The CBN will sell to BDC’s at N378/$1 while the BDC’s will sell to end-users at “no more than” N380/$1.

GTBank 728 x 90

Single Exchange Rate: A report yesterday also suggested that the CBN also planned to move to a single exchange rate policy for determining the price of the dollar. A senior central bank official who does not want to be identified, said, ‘Today we allowed the rate at the importer and exporters (I&E) window to adjust in response to market developments.’

The central bank has now made an apparent u-turn after it had initially that the “market fundamentals do not support naira devaluation at this time” detailing reasons why it did not need to devalue.

Falling oil price: Oil prices fell to under $20 on Friday before climbing back up to settle at $23 per barrel. Nigeria’s Bonny light trades at $26 while the benchmark Brent crude trades at $29 per barrel. In response to the crash in oil price, Nigeria’s announced a cut to its 2020 budget by N1.5 trillion as it faced the reality of a potential drop in its revenues. Nairametrics also has information that state governments are getting jittery about their ability to sustain salary payments as a reduction in their federal allocation “FAAC” is anticipated.

Patricia
Continue Reading

Career tips

Investment options for salary earners

Investment options for the salary earners
#Investing #Entrepreneurs #Investment #Salary #Wages

Published

on

Investment options for salary earners - bank loan

Recently, one of the readers of my articles asked to know what investment options are open to salary earners. A salaried individual is like everyone else except that he or she has a fixed monthly income. This implies that their investments and expenses have to be managed strictly according to their fixed monthly income.

Since salary is assumed to be the only source of income for the salaried, it is advisable that such an individual fortify himself financially before investing so that adverse investment performance will not have untold effect on him and his family. Therefore, if you are a salaried prospective investor, you need to:

UBA ADS

Get life insurance

Most families in Nigeria are single income families so much such that if anything bad happens to the income earner, the family gets shattered, at least financially. Again, given the risks inherent in capital market investments, it is only prudent to have a life insurance as a first step in one’s investment journey. It is very baffling to see many investors very deep into the market, yet they do not have life insurance.

[Read Also: Understanding the risks in bond investing]

Life insurance is and should be a basic part of any financial plan. Life insurance is a protection for loved ones against financial hardship arising from the death of a breadwinner. This is even more important today than ever before with high cost of funeral expenses, college education and medical bills. So, the first investment option for a salaried individual is to get a life insurance.

GTBank 728 x 90

Prepare for financial emergencies

Life is full of surprises, emergencies do happen, jobs are lost without notices, and even good investment opportunities emerge sometimes suddenly. There is, therefore, the need for a cash reserve to help weather the financial storms and emergencies when they come calling.

Cash reserves do not only provide for emergencies, they also help to ensure that investments are not liquidated prematurely or at inopportune times to cover unexpected expenses. There are no hard and fast rules on what the exact amount of the required cash reserve should be, but most financial experts and planners will advise that an amount that equals about six months of living expenses be set aside.

So, as a salaried person, your next investment should be to have a cash reserve. A cash reserve should not necessarily be in a savings account or under the mattress; it could be in an interest-bearing money market account, money market mutual funds with low to zero luck-up period or another form of very liquid investment that is readily convertible to cash without loss of value.

[Read Also: Understanding the risks in bond investing]

Know your risk appetite

As a salaried and fixed income individual, your risk appetite is most likely going to be low as well as your risk tolerance, although your extended family profile could change all that. You need to know or understand your risk tolerance before you engage in any capital market investment.

Your risk tolerance will and should drive the type of investments you go into. Your risk tolerance depends on your psychological makeup, your current insurance coverage, presence or absence of cash reserve, family situation, and your age among others.

app

Talking about family situation, it is reasonable to think that a married individual whose children are still in school will be more risk averse than an unmarried person. On the other hand, older people have shorter investment time horizon within which to make up for any losses. the reason for this is because the older you get the less time you have to work to recoup on losses.

In that case the risk tolerance of an older man will be less than those for younger folks. Again, the more cash reserve and insurance coverage you have, the more your propensity to take risk. Now having known your risk tolerance based on the underlying factors, you can then define your investment objectives

[Read Also: Important tips on how to profit in a bearish market]

devland
Coronation ads

Set your Investment objectives/goals

Having met those essentials above, you are now ready for a serious investment plan or program. A good investment plan starts with investment objectives. Investment objectives are the force that determines what you invest in. Investment objectives range from capital preservation, to capital appreciation and constant income generation.

Capital preservation as an investment objective implies that you, the investor, aim at minimising the risk of loss by maintaining the purchasing power of your investment. So, if you are risk averse or you will need money from your investment soon for children’s education or for building a house or you are nearing retirement, this should be your objective.

GTBank 728 x 90
thegreenafricaproject 300x250

Investors whose aims are to see their investment portfolios increase in real terms over a period of time are better suited for capital appreciation as an objective. This is better for investors that are more risk tolerant and those with more potential to recoup on losses along the way.

If you are already retired or nearing retirement, and therefore depend on your retirement plan supplemented by investment income, you need an investment that generates income rather than capital gains. In that case, your investment objective should be current income generation. It is always good to have investment goals stated in terms of risk and returns.

[Read Also: I-Invest generates over N2 billion transaction in less than 6 months]

Decide on asset allocation

Armed with the knowledge of your risk appetite and investment objective, you are now ready to decide on what to invest in, and how much to invest in any asset class. This takes you to asset allocation decisions. Asset allocation involves dividing an investment portfolio among different asset classes based on an investor’s financial requirements, investment objectives and risk tolerance.

A right mix of asset classes in a portfolio provides an investor with the highest probability of meeting his/her investment objectives. Asset allocation is the most important investment decision an investor can make in a portfolio because it demonstrates an investor’s understanding of his or her risk preferences and return expectations.

It is good to strive for a diversified portfolio. Unfortunately, the Nigerian market does not provide a lot of asset classes for optimal diversification, but diversification can be achieved across sectors or industries within the few asset classes in the Nigerian stock market.

Decide on how to invest

There are different ways to invest in the capital market. You can invest directly by making the stock selections by yourself, thanks to the online stock trading platforms that abound the world over. This implies that you have what it takes to conduct the required research and analysis of the companies whose shares or stocks you wish to buy.

first bank
app

[Read Also: How I Would Invest My Mother’s Retirement Funds]

It also implies that you have what it takes to know when to sell or add to existing positions. Another method is to have someone “do the heavy lifting” for you. In this case, that someone, often times called fund manager or portfolio manager, does the research and analysis and selects shares that suit your investment preferences, investment objectives, risk tolerance and appetite as well as your investment time horizon.

This route is most suitable for investors that lack the knowledge and time for the required research and analysis. If you decide to go this route, mutual funds are the best bet for you.

Patricia
Continue Reading

Business News

Atiku kicks as Buhari spends $3.7 billion in foreign debt service since 2015

Published

on

Budget: FG completes just 31.7% of constituency projects, Nigerians react to President Buhari's signing of Finance Bill 

The Buhari led government has spent about $3.7 billion in foreign debt service since 2015, one of the highest from any democratically elected government. The highest single-year foreign debt service was in 2006 at $1.79 billion.

About 68% of Nigeria’s foreign-denominated debt servicing is in commercial Eurobonds issues over the last two years. The loans range between 5.1% and 9.2% per annum. Nigeria’s external debt stock stood at $27 billion in June 2019.

UBA ADS

Rising debt service: The Buhari administration has so far spent about $1.1 billion in foreign debt service this year. In 2018, the government spent about $1.4 billion in debt service, more than 3 times the $444 million it spent servicing foreign debts in 2017. The rising cost of debt service is a direct attribute of the government’s reliance on foreign loans as a means of funding government expenditure.

Debt service since 2003. Source: CBN. Nairametrics Research (C)

Foreign Loans: Nigeria’s fallen revenue following the crash in oil price has allowed President Buhari to rely mainly on foreign loans to fund government expenditure. As of June 2015, Nigeria’s foreign loans were about $10.5 billion mostly made up of multilateral and bilateral loans.

GTBank 728 x 90

However, by June 2019, total foreign-denominated loans were $27 billion with $10.8 billion made up of Eurobonds. Commercial loans which include Eurobonds and Diaspora bonds make now make up about 42% of total foreign borrowings.

[READ ALSO: Babatunde Fowler attributes FIRS success to technological innovation (Opens in a new browser tab)]

Critics of the government have complained about the government penchant for debts believing that it could put the future of younger Nigerians in jeopardy. Supporters of the government, however, believe the borrowing was necessary to invest in critical sectors of the economy particularly infrastructure.

Recently, Director-General of MAN, Segun Ajayi-Kadir expressed worry about Nigeria’s rising debt.

“….the rising debt profile of Nigeria continues to be a cause for concern, especially the capacity of government to effectively service it and, at the same time, meet the bursting needs and aspiration of the citizenry going forward.” 

“Already, our budget projections for 2020 anticipates a debt service sum of 2.45trillion, an amount higher than the 2.14 trillion earmarked for capital expenditure. 

app

“And even though our debt-to-Gross Domestic Product (GDP) ratio, which currently stands at 28 percent, is still below the average in Africa, our revenue-to-GDP ratio remains low.”

The Finance Minister Zainab Ahmed however, believes the current debt profile is sustainable, comparing it to our GDP.

“Currently, Nigeria’s debt is at N25 trillion; that is about $83 billion. And at $83 billion, we are just at 18.99%…so 19% debt to GDP. I hear people say Nigeria has a debt problem. We don’t have a debt problem. What we have is a revenue challenge and the whole of this government is currently working on how to enhance our revenues, to ensure that we meet our obligation to service government as well as to service debt.”

devland
Coronation ads

[READ ALSO: Babatunde Fowler attributes FIRS success to technological innovation (Opens in a new browser tab)]

Former Vice President and defeated PDP Presidential aspirant, Atiku Abubakar during the week piled criticism on the government’s borrowing.

GTBank 728 x 90
thegreenafricaproject 300x250

“I have said it time and again. The business of government is too serious to be left in the hands of politicians. We must all ask questions because if they throw away the future, it is not going to be their future they are throwing away, it will be all our futures.

“The fact that Nigeria currently budgets more money for debt servicing (N2.7 trillion), than we do on capital expenditure (N2.4 trillion) is already an indicator that we have borrowed more money than we can afford to borrow. And the thing is that debt servicing is not debt repayment. Debt servicing just means that we are paying the barest minimum allowable by our creditors.

What this means: Nigeria’s rising foreign debt profile should be a worry to investors and businesses and must be watched closely. The country’s ability to repay these loans will continue to be harder as it increases especially now that it is costing about 9%. The immediate risk for investors is the exchange rate which could be the first to suffer should the government struggle to repay its loans.

Patricia
Continue Reading
Advertisement
Advertisement
Patricia
Advertisement
Advertisement
first bank
Advertisement
devland
Advertisement
devland
Advertisement
GTBank 728 x 90
Advertisement
Advertisement
financial calculator
Advertisement
devland
Advertisement
app
Advertisement