The Road Not Taken when Investing

Published on 4th July 2006

Retail investors have asked me severally for an honest opinion on an equity fund as an investment proxy to stocks. With the increasing media hype on the two investment options (shares and equity funds), many have found themselves torn between the two and are unable to choose what’s right for them. In addition, one may be wooed by the success of a colleague to rush for an investment that may not equally work for him/her.

 

Having taken time to go through all the queries that I have been receiving from people who have raised the issue, my conclusion is that a majority of ‘to be’ investors do not weigh out their investment objectives before joining the investment labyrinth. In addition, the industry is characterized by masters of either equity funds or shares and rarely do we get people giving investors the option of choosing from either of the two.

 

I almost got into a heated argument with a marketer recently after being accused of having misled an investor to venture into shares thus withdrawing from an investment fund. One needs to first understand what equity funds are and their principal benefits. 

 

According to The Motley Fool, an online investment advisor, equity fund is simply a collection of stocks and /or bonds.  Most mutual funds are actively managed meaning that mutual fund shareholders, through a yearly fee, pay a fund manager to actively buy and sell stocks or bonds within the fund. The underlying advantages from an equity fund are those of portfolio diversification and professional management. It is however important to note that investing in equity funds involves risk. In addition, fees and taxes diminish a funds return.

 

Debate arises over the two major issues - return and cost. Most investors after knowing the returns compared to stock market returns would opt for the shares, investment objectives aside. Below is an illustration of the returns of five companies listed in the Nairobi Stock Exchange (NSE). If one held a portfolio of these five companies for the past one year, his/her average return would have been 85.30%. 

 

5 Listed Companies

 

Conversely, the average returns on equity funds can range from around 25% to 35% and even lower in very efficient markets like the United States where returns are at an average of 12% compared to a return of around 14% on shares listed in the two stock markets (NYSE and NASDAQ).  Below is an illustration of returns of one of the best yielding Equity Funds in Kenya.

 

 

5 Listed Companies

 

Typically, one will give a fixed monthly build up to a fund manager and expect a return after a specified period of time. This means that with as little as Ksh.5,000 (USD.68), one can own a lifetime investment through an equity fund. With the recent suspension of Uchumi Supermarkets from trading at the Nairobi Stock Exchange (NSE) and a profit warning posted by Unga Group Limited, most investors are losing their appetite for low cap stocks. Most of these stocks were the favourites of most retail investors because of their quick returns. With Ksh. 5,000, one would have afforded at least 300 shares of either of these low capped stocks.  That’s not expected anymore as the best performing stocks are in the range of Ksh. 40 (USD 0.54) - Ksh. 130 (USD.1.78) today.  Most investors will now have to do a lot of homework before betting on any counter at the stock market.

 

The costs of equity funds however far outweigh those of shares.  For an investor to trade in the Kenyan market for example, you would incur a cost of 2.1% for a transaction of less than Ksh.100,000 (USD.1,369.86) and 1.8% for transactions of more than Ksh.100,000 (USD.1,369.86). In addition, gains on shares are not subjected to tax as deduction is usually done at source. For equity funds however, the expense ratio is the biggest nightmare for an investor. This fee comprises of the investment/ management fee, administrative costs. Where applicable, load costs also have an impact on the overall charge on a fund. 

 

The bottom line is, one’s investment objectives must always come before hand.  Identifying your investment objectives will enable you determine what you want your money to do for you ranging from short term to mid term and long term. As the old adage goes, do not put all your eggs in one basket.  It would be important to diversify one’s portfolio. While venturing into the stock market, one should dedicate some funds to the fund manager. In doing so, the equity fund will help you invest for the long term while shares will take care of your short term and mid term investment goals.


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