In the last article we talked about Fixed Income Assets. Today we will focus on Contractual Savings and Mutual Funds..
Contractual savings is making a regular payment into long term investments. Two main group are insurance and pension funds
Insurance is a promise of compensation if specified events occur in the future in exchange for periodic payments called premium.
The benefit of insurance is that it protects individuals or companies (policyholders) from unexpected losses. Once you agree and sign the terms of an insurance, you become a policyholder. In most cases, if the specified event occur, the policyholder pays part of the loss (called the deductible) and the insurance company will pay the rest.
Forms of insurance include
- General insurance – protects policyholders against personal injury, accidents, theft, fire examples are car insurance, house insurance, health insurance, business insurance.
- Life insurance – protects policyholders in the event of death of the insured. The insurer agrees to pay certain amount of money to the beneficiary when the insured dies.
The benefits of having Insurance cannot be over emphasized. Insurance indemnifies the policy holder from losses. It helps the policy holder to recover lost assets easily with less cash flow.
Before signing any insurance policy, it is important that you make necessary inquiry about the company, especially its history in terms of claims payment.
This is a plan or scheme which provides retirement income for employees to live a comfortable life after retirement. The contributions are made either by employee, employer or both.
The pension payments are determined by the length of the employees’ working years and the annual income they earned on the job leading to retirement.
How does it work?
A fixed percentage of employee’s salary is put in retirement savings account (usually with pension funds). The savings is then invested on behalf of the employees in stocks, bonds, mutual funds, TBs, CPs. These assets will appreciate in value overtime, thus providing a good income for the employee during retirement.
The employee can choose to collect the pension benefits as a lump sum upon retirement or periodically – annually during the course of his/her retirement.
Pension plans are calculated based on three key criteria
- Employee’s year of service at a specific firm
- The employee’s age
- The employee’s annual compensation.
Different organizations have different policies regarding pension plan. You need to make sure you understand the policy of your organization especially regarding the years of service.
If your company does not offer a pension you have options. You can establish individual retirement account plan with a pension fund company and deposit percentage of your annual income in other to guarantee steady income during your retirement.
This is a pool/collection of money from many investors (individuals or institutions) to invest in securities such as stocks, bonds, Treasury Bills or Commercial Papers.
Mutual funds are operated by professional fund managers for the purpose of achieving capital gains on the assets or income for fund investors.
Mutual funds give individuals opportunity to invest with small amount of money in a diversified portfolio managed by professional fund managers. Thus, significant amount of risk is reduced through diversification.
The value and yield of a mutual fund is calculated and adjusted daily depending on the performance of assets in its portfolio.
In Nigeria, you can invest in mutual fund with as low as N10,000. Some mutual funds charge management fee on your capital while some take a percentage of your profit. However, some don’t charge any fee at all. Therefore, before investing mutual, do your due diligence about the company and confirm the nature of their charges.
Note that a minimum holding period of 3 months usually apply to mutual funds. This means that you will not be able to withdraw your investment within the first 3 months. However, in some companies you pay charge of 20% if you must withdraw within 3 months. Though this varies from company to company
So before investing in mutual funds be sure to read the terms and conditions.
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There are different kinds of mutual funds depending on the kinds of securities the fund is invested. Examples are
- Equity funds – invested stocks
- Fixed income funds – invested in bonds – government and corporate.
- Index funds – invested in selected market index
- Money market funds – invested in short term securities like Treasury bill and Commercial papers
All these funds have different returns on investment depending on the returns on the mutual fund portfolio.
Before one can make investment decisions, he/she must decide on the objective – that is the return and risk tolerance level because return and risk are directly related to each other. This is called risk – return trade-off.
Remember that the higher the risk, the higher the return to compensate for the risk. Therefore, an investor need determine and specify his/her objective.
Asset allocation is very important in making investment decisions. There are different kinds of assets you can invest in such as equities, bonds, Treasury Bill, Commercial Papers, real estate, precious metals, insurance, mutual funds etc.
You need to decide the proportion of investment to be allocated to each of these assets, that is the percentage of your fund/money that will go into each asset.
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You also need to analyze these securities before investing, to determine the attractiveness of each asset bearing in mind that inflation affects investments and that return depends on the level risk involved.
Finally it is very important that you hold a diversified portfolio by investing in different assets in order to reduce your risk.
I will leave you with some of my quotes
“Investment is like a seed, if it is sown on a good fertile ground and under the right atmosphere and climate, it will germinate, grow and bear fruits thereby yielding more seeds but if it is sown on a bad soil/ground, it will die yielding little or no seeds”.
“Don’t spend all your money today, invest in your future”
In the next article we will focus on “equity/stock investment.”