Thursday, May 26, 2022

Njega: How to avoid scams and make wise investment decisions

This feature on how to avoid scams and make wise money decisions in Kenya was written by Economic and Financial Analyst Ephraim Njega: I don’t know where people got this impression that trading in currencies is the easiest way to get rich these days. Before you invest in any asset you need to understand about the principles which guide such activities.

1). You need to understand the nexus between risk and return – when you hear about returns always think about the corresponding risks involved. There is no investment without risk. Even government securities carry risks such as inflation. Serious investment is about taking calculated risks. When someone is selling you an investment with very high returns remember the risks are also likely to be very high. If someone is selling you an investment where they are just emphasizing the returns without disclosing the risks that should be a red flag.

One of the greatest risk management tools is diversification. As the saying goes; “don’t put all your eggs in one basket.” Always invest in different asset classes. Even within one asset class invest in different categories of the asset. For instance, invest in real estate and stocks as two different asset classes. In real estate, invest for example in rental and commercial real estate as different categories within the asset class. In stocks, invest in different categories e.g. manufacturing, agriculture, financials, energy, ICT etc

Because of risk inherent in investment, you need to be aware that you can lose all the money invested. Neither return on capital nor return of capital is guaranteed. Don’t invest what you can’t afford to lose or you will in the end lose yourself to stress

2). Understand your personality and how it influences how you invest – You should also understand your risk management personality, risk profile and risk carrying capacity. Are you a risk taker or risk averse? If you are a risk taker be careful because you are more likely to be driven by impulse. This makes you susceptible to making bad investment decisions.

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If you are risk averse be careful not to become a captive of fear and analysis paralysis. This makes you susceptible to missing investment opportunities. You will end up always getting into a party when people are on their way out and wondering if you are bewitched.

There is saying; “break bones when you still have teeth.” When you are young and with fewer financial responsibilities your risk carrying capacity is high and it is the best time to invest. You make mistakes early and learn early. You also benefit most from the power of compounding

3). Investment horizon – it is said that the markets are able to remain irrational longer than you can remain solvent/liquid. Prices of traded assets rise and fall all the time. That is why you need to think about the duration of your investment. Don’t invest money you need soon in an asset that will take long to grow in value. You could be forced to sell at a loss. The saying “don’t invest grocery money in stocks” also applies to other investments.

Remember the difference between speculating and investing. Speculation is about short-horizon, high-risk, quick-gain mentality. Investing is a long term, slow but sustainable wealth creation mentality

4). There are no quick gains or overnight riches in serious investment – don’t invest in something just because another person invested and booked quick gains. Evidence of a windfall is not evidence of its future repetition. Even when you invest in something and make quick gains don’t try to repeat the same. There is a saying that says “don’t hang around to dry in the same river you have bathed in.” Above all, let you investment decisions be driven by clear objectives not hype and fairy tales

5). There is no shortcut to doing due diligence – always do you own research and investigations to ensure that what you are investing in is legal (has complied with all laws and regulations) and that the institution you are investing through is operating legally and professionally.

Unless you are a sophisticated investor, avoid investing in or through unregulated firms. Financial regulators in Kenya include; CBK, IRA, RBA, CMA, SASRA etc. While investing through a regulated entity doesn’t mean you can’t lose your money, it minimizes the risks and sometimes offers some recovery options in case of loss. Even when you engage an investment professional, don’t leave everything to them.

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6). Investing is driven by knowledge – before investing your money in something begin by investing in knowledge about that asset. Only invest when you are confident you have enough knowledge about what you are getting into. Before you invest in cryptocurrencies understand what they are and the blockchain technology behind them.

The other way of gaining knowledge is practice. You can practise by using fantasy investment system or using real money. In a fantasy system, you are allocated digital money (not real money just a figure) you then buy the asset you are interested in and see how it behaves. You practise till you understand how the real market works before you go into the real market.

If you must use real cash, don’t invest everything at once. Invest in batches taking in the lessons learnt. Remember the saying; “don’t test the depth of a river with both feet”

7). Understand the sentimental and fundamental issues that drive financial markets. Prices of traded assets are influenced by both subjective and objective issues. Emotions such as hope, fear and greed are key drivers of prices. Objective reasons such as performance of the asset also play a key role.

You need to understand whether you are trading on emotions (speculating blindly) or on facts (investing wisely). Don’t be driven into investing by Fear Of Missing Out (FOMO). This is how people are recruited into scams

8). Don’t follow the markets blindly – whenever you hear hype about an asset be careful not to jump in blindly. If you hear for example that the price of Bitcoin is rising sharply ask yourself why? Is the reason behind such a rise likely to sustain the price rally and for how long?

If you just buy without knowing why the price is rising you wouldn’t know when to exit. Timing the market is almost as risky as gambling. Even when you forecast a price rise or fall remember the first rule of forecasting is that “all forecasts are wrong”. Have your entry and exit price and stick to that if investing for the short run

9). The house never loses – this is a well-known maxim in gambling but you can also use it when investing. My point here is to think about the person selling you investment or urging you to invest. In most cases, this person will profit whether you gain or lose. For example, when a stockbroker is telling you to buy or sell a certain stock remember they will earn their commission whenever you transact. Ensure the advice they give is not conflicted by their interest

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10). How much skin in the game? – this concept is all about walking the talk. Ask yourself how much the person selling you an investment has invested in the same. For example, when you invest in a company where the CEO, directors and top managers have no shares in ask yourself why? Is it because they have no confidence in the company?

If a person cannot risk in what they are asking you to risk in, does it mean they love you more than themselves? Those people running the investment scheme you are getting into how much are they exposed to the risks they are exposing you to?

In conclusion, always think about these issues. First the asset you are investing in. Secondly, the person selling you the investment idea. Thirdly, the people managing what you are investing in. Fourthly, think about yourself as an investor i.e. what is driving you to invest and what are your investment objectives. Lastly, think about the risks involved and whether you can bear them.

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