Alhaji Kareem retired from the Federal Ministry of Works and was paid N28m in gratuity and ‘others’. Ecstatic and determined not to squander the funds, he decides to invest his funds in shares and calls his stockbroker to buy him shares in banks, FMCGs and oil and gas companies. Then all he has to do is wait for his investments to make good returns.
By 2009, his N24m investment in shares has been depleted to roughly about N16.2m. Bitter and angry, he shouts for his stockbroker to sell quickly so he can cut his losses and move on. He vows never to buy shares in life again and to instead invest in landed properties henceforth.
What he could have done differently to reduce the losses he incurred on his investment is Risk Diversification.
Today, we hear from our Corporate Finance Analyst, Adedolapo Adeniregun as she explains the nuances of Risk Diversification and how it can make investing less risky and more profitable overall.
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RISK DIVERSIFICATION: GUARANTEED-RETURNS INVESTMENTS
Guaranteed Returns investments refer to investments on which the company is required to pay returns. Returns on this kind of investment are agreed upon and are not affected by the state of the economy or the prices in the finance market.
Basically, a guaranteed returns investment generally constitutes a lower level of risk for you because they refer majorly to debt instruments i.e. instruments upon which a rate of return is pre-agreed. This means that the investor is guaranteed that come what may, he/she will get the return agreed with the company/entity.
Examples include bonds, government treasury bills, Rosabon Treasury Note (RTN), etc. With these instruments, the investor is not concerned with the performance of the project the company has raised funds for as he knows just how much he will get at the end of the agreed tenor.
This is not to say that guaranteed returns investments are the better option, as they each have their advantages and disadvantages.
However wise investing is about building as diverse a portfolio as possible. The more diverse your investment portfolio is, the more spread out your risk is.
It’s not about how much you invest, but how smart you invest.
An investor who wants to build a well-diversified portfolio should strive to hold securities in various classes, as well as a mix of performance-based and guaranteed-returns investments.
The wisdom is not in asking which is the better option; performance-based instruments or guaranteed-return (debt) instruments but in ensuring that you hold both.
