SUNBIZ

Better To Put Your Money In Bank Or Shares?

In this article, I will discuss two forms of investing your fortunes to make more of the same. In my previous article, I provided a broad brush picture of some
15 Nov 2014 00:00
Better To Put Your Money In Bank Or Shares?

In this article, I will discuss two forms of investing your fortunes to make more of the same.

In my previous article, I provided a broad brush picture of some important factors to consider when investing in companies.

I touched on the risks of investing, quality of financial information, role of the external auditor, and rigour of the institutional governance.

Today, I will delve deeper into the risks and returns through real examples.  The purpose is to illustrate the risk and return one faces when investing in a listed company in Fiji.

One of the most widely-cited reason for investing in the shares of a company is the handsome returns one can derive.

However, returns on shares need to be placed in some context and compared to an alternative form of investment.

The most common form of investment or savings by the majority in Fiji would be to put the money in the bank so I will use this as the benchmark.

But before I get into the numbers game, let me explain a few concepts and key terms.

Some concepts and terms

What is a share that one buys and what rights does it convey to the holder of a share?

A share is a form of ownership in a company.  Depending on the level of ownership and the type (or class) of shares, the holder may have some rights.

For example, individuals holding minimal shares, say 100 shares out of 500,000 shares (0.02%) in a company listed on the SPSE, usually have very little influence on how the company is run.

Individuals owning this level of shares are known as minority shareholders.  Individuals holding five per cent or more are known as block holders and can have some influence.

And when institutions own shares in a company, such as the FNPF, it can have considerable influence on the company’s operations, management, governance, and so on.

However, if minority shareholders get together and “theoretically” pool their shares, they could as a group influence the company and/or take action against a company.

Such actions are dependent on the company laws and financial regulations in Fiji and certainly are not free and will incur financial and legal costs.

When you buy shares in a company, what evidence do you receive that you own part of the company?

Well, just like any other financial transaction, you will be given a share certificate either electronically or on paper that identifies the number of shares you own, the name of the company, the date of the transaction, etc.  This “certificate” will be your record.

Shares and fluctuations

In an active share market, the price of the shares in a company fluctuates and it can increase, decrease or show no change.

The direction of the fluctuation depends on many factors. These include, amongst others, good and bad news about the company, good and bad news about the economy, good and bad news about the political environment, and of course, the mood and psychology of the investors.

In Fiji though, the share market is not volatile; meaning share prices do not fluctuate frequently.  It is a market where share trading activity is not high.

So what do I mean by share trading?  When you buy shares in a company that already has shares listed on the SPSE, you are buying it from another shareholder who is willing to sell the shares at an agreed upon price.

It is similar in concept to buying dalo at the Suva market, where a willing seller and buyer agree on an exchange price.

The buyer will in all likelihood inspect the dalo for quality, freshness, and then determine if the purchase is value for money.

Similarly for buying shares, while you do not necessarily know who the seller is, you will need to understand the company you are investing in.

Is the company a safe investment?  Will I make or lose money by owning shares?  How do I know that the company (dalo) is of good quality?

Answers to some of these questions were provided in my article in September.

So assuming the company is of good quality, then the next question is, should I buy the shares or put the money in the bank?

The dividends

In addition to the share price increasing or decreasing, companies pay dividends.

A dividend is basically a portion of the profits given to owners of the company, meaning the shareholders.

Usually and not always, a company will declare a dividend and in the ensuing months will pay out the dividend in cash.

Dividends can also be paid by way of a bonus share issue but this is rare in Fiji.  Dividends are paid per share so the more shares owned, the greater the dollar value of dividends received.

A company is not required by any law or regulation to pay a dividend so be warned that a company can suddenly terminate or suspend its policy of paying dividends.  Or a company that never paid dividends can initiate a dividend payout.

Therefore, because you bought shares in a company do not expect or demand the company pay you a dividend.

If you do not like the company because it stops paying dividends, then you can sell the shares you own and reduce your risk.

However, note that you will either make a loss or gain when you sell the shares depending on the share price at the time of sale.

If you sell the share for more than what you paid, you will make a gain.  If you sell for less than what you paid then you will incur a loss.

Money in a bank

I now turn to illustrating the differences between money in the bank or in shares.

First, putting money in the bank is relatively safe but it depends on the bank.  Some banks have been around for a long time in Fiji such as Westpac (Bank of New South Wales), ANZ and Bank of Baroda while others are relatively new.

You need to know and understand how safe or protected your principal (money you put in the bank) is?

This will depend on Fiji’s banking regulations, which can be obtained from the Reserve Bank.  Unless a bank liquidates, and this very rarely happens, money in the bank is quite safe.

Second, with more safety comes less risk, and hence, the return on money in the bank reflects this.

For example, currently the 12 month term deposit rate ranges between about 2.05 per cent and three per cent per annum, depending on the bank and minimum requirements.

The requirements are usually a minimum $500 or $1000 deposit, no withdrawals during the 12 month period, and so on.

Imagine you deposit $1000 in a 12 month fixed deposit with three per cent interest to be paid at maturity (end of the 12th month).  The interest you will earn is $30.

Assuming you use the interest but keep the $1000 in the bank and renew the term deposit assuming the same interest rate, interest payment date, and interest withdrawal pattern, then over five years you would have earned $150 in interest.

The money you invested stays at the same value of $1000.  I am ignoring inflation in this example and the one below.

Meaning if the general cost of living increases over the five year period then your principal of $1000 will not have the same purchasing power it had five years ago.

With inflation, your purchasing power decreases.

Money in shares

Now consider investment in shares in a company.

Assume you invest in one of the companies on the SPSE that has a share price of $1.

Now assume that this company, which I will call XYZ for illustration, pays annual dividends of $0.10 per share each year and has been doing so for the past four years.

When you invest $1000 to buy shares at a price of $1.00 per share, you will receive 1,000 shares.

Since XYZ pays a dividend of $0.10 per share this means you are entitled to dividends worth 1000 shares multiplied by 10 cents, which equals $100.

Assuming you keep your shares and do not sell them for five years, and XYZ keeps paying $0.10 dividends per share for five years, and you use the dividend for personal purposes (not buying more shares) then you will have earned a total of $500 over five years.

This is so much more than the $150 you would have earned by putting money in the bank.

In fact, the rate of return per year assuming the share price stays the same is 10% for investing in shares whereas the bank deposit rate of return is 3%.

The scenarios

The scenarios above are very simplistic and ignore the increase or decrease in the price of the shares.

If the price of the shares you own in XYZ increases then you will make a paper profit which is the difference between what you paid and the current price.

Now you might decide to buy more shares in XYZ because its share price increased by 10 cents.  When share prices increase, it suggests the capital market (investors in general) expects a company to do well in future.

So let’s assume you buy additional 1000 shares at $1.10 each and dividends remain at 10 cents per share.

Now you have two different initial investment values; one at $1.00 per share and another at $1.10 per share.

Using these initial values, your return on investment based on dividends is 10% and 9%, respectively.

But you will still receive $100 for each parcel of 1000 shares (1000 x 10 cents), meaning your total dividends would be $200.

Now if we add the gain in share price of 10 cents, the first 1,000 shares you purchased is now valued at $1.10.  This is a 10% gain in value.

Theoretically, your return on investment is much more than nine per cent.

Simplistically, your total returns are $300 in this particular year and your total investment is $2100.  So your gross return is about 14 per cent ($300/2,100).

The downside

You probably are now thinking, this is really great and I can make some money just by buying shares.

Buying shares incurs transaction costs, meaning you will need to pay a broker for buying the shares of companies in the SPSE.

I am not sure if financial institutions in Fiji allow you to trade in shares through services they provide to their retail customers (individuals not businesses).

I recommend you speak to a broker or financial advisor before undertaking any major share investment.

You may also want to consider investing in shares of companies overseas such as in Australia, New Zealand or the USA.

The downside is that you may not have much understanding of these overseas markets.  The upside is that these markets have good shareholder protection regulations.

Nevertheless, each investment opportunity will have risks so do your “homework” and assess your risk appetite before taking the plunge in the share market.

– Professor Divesh Sharma has more than 25 years of experience analysing companies’ financial performance.  He has written numerous articles on this topic and provided consulting to audit firms, corporations and financial institutions, and training seminars in Australia, New Zealand, Singapore, USA, and Fiji.  He can be reached at dsharma2@kennesaw.edu.  The opinion expressed here is that of Professor Sharma and do not represent the views of Kennesaw State University.

 




Fiji Sun Instagram
Fiji Plus
Subscribe-to-Newspaper