The first Financial Jargon Buster

The first Financial Jargon Buster - Afrika Kesho

I’ve studied quantum mechanics, cosmology and mathematics, and I’ve come across terms like bremsstrahlung, blackbody radiation, and cholesky factorization, but none of the terms in any of those subjects are ever as difficult to understand as the terms in the world of finance. And it’s all very systemic, because if you don’t understand something, then you either have to rely on someone else who understands it, or you can easily be taken advantage of. That’s why important it is to understand financial terms, and so it is important have jargon busters like this one.

Because the jargon in the financial industry is systematically difficult, we need to make jargon busters systemically easy to understand. I’m going to start with the basics of how the finance industry works, and then delve deeper and deeper in future jargon busters. This is the first in a series of jargon busters, keep your eyes open for the next editions.

Here’s a short list of words and terms that serve as an introduction into the world of finance. I tried my best to let them flow in a certain kind of order:

1. Financial instruments, financial securities or financial claims are certificates or some form of contracts that have monetary value, can be traded and entitle you to payment in the future. An example of a financial instrument is government bonds.

2. The financial system is made up of financial markets, financial intermediaries and other financial institutions that carry out the financial decisions of households, businesses and governments.

3. The term financial markets includes marketplaces and the systems around them where financial securities can be bought and sold.

4. Lenders (or investors) are those who buy or invest in securities. Lenders save.

5. Borrowers are those who use the savings. They borrow the money, and by doing that they are issuing the securities that are being bought by lenders. As an example, if you buy a government bond, you are the lender, and the government is the borrower.

6. Financial intermediaries are how money flows from lenders to borrowers. They serve as both issuers and buyers of securities and other debt instruments because they buy from lenders and sell to borrowers. Banks and insurance companies are examples of financial intermediaries.

7. Brokers (or agents) buy and sell financial securities on behalf of lenders and borrowers.

8. Financial advisors guide investors on their investments and give recommendations on which financial securities to buy or invest in.

9. Dealers (or jobbers) buy and sell financial securities for their own account.

10. The bid price is the maximum price that a buyer is willing to pay for a financial security.

11. The ask (or offer) price is the minimum price that a seller is willing to sell that same financial security.

12. Market makers make it easier for buyers and sellers to transact by being willing to buy or sell certain securities at all times. They quote both a bid and an offer price to the market and profit from the difference between the bid and offer prices, called the spread, as well as from changes in market prices.

I hope that I simplified these terms and have helped you understand the world of finance more.

Happy investing!

This article was written by Tumelo Koko.

You can contact Tumelo Koko by clicking on the social media buttons below, or by emailing him on: tumelo@afrikakesho.co.za

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Introduction to investing strategies #2

Introduction to Investing Strategies 2, Afrika Kesho, by Karabo Manasoe

In my last article, Introduction to investing strategies #1, I talked about the growth investing strategy and the value investing strategy – today, it’s dividend investing and momentum investing.

Before I dive in, let me explain what a dividend is.

A dividend is money paid to someone who owns shares in a company, for simply owning those shares. You can think of a dividend as a form of “thank you” for the money and trust you put in the company you own shares in. This is because as an investor in a company, you own part of the company and so you put your trust in the people who run the company to make good use of your money and grow your investment. This trust in the company and the risk of losing some of your money if the company’s share price goes down is rewarded in the form of a dividend payment.

Dividends are paid from the company’s profits, and not all companies pay dividends – it’s up to the management of the company whether the company pays dividends or not. If the profits of the company would be better off being reinvested in the company, like is the case with most small companies, the management chooses not to pay dividends.

Regardless of your investment strategy, if a company you have shares in declares that they are going to pay dividends, you will receive your payment.

The Dividend Investing Strategy

What it is

The focus of the dividend investing strategy is on, guess what, dividends. As a dividend investor, you look for quality companies that have good dividend pay-out policies. By choosing only companies that reliably pay dividends, you create a source passive income for yourself. This is on top of the money you earn when the value of the shares you own goes up. This income source can grow to be substantial over the long term, and you can get to a point where you can live off your dividends.

The investor who uses the dividend investing strategy has two options when looking for quality companies:

  1. They can either put their money in companies that are mature, and so are in a good financial position to pay dividends consistently, or
  2. They can put their money in companies that are paying out small dividend amounts in the short-term, because they believe that the dividend amounts will grow in the long term, because the company has the potential to grow.

The second approach (2.) above is often called the dividend growth investing strategy. It can be thought of as a modification of the first approach (1.).

Dividend Investing

Personality of a dividend investor

As a dividend investor you must have patience. As the size of your investments grow over the long term, either from you investing more of your income or by you reinvesting the dividends you earn, you will receive bigger and bigger dividends. This is because the more shares you have in a company, the more dividends you get from that company.

Another quality you have is that you seek safety and security – you are “boring”. Since the focus of dividend investing is mature companies – usually old and stable companies that may not be trending on the news or social media – you must make peace with the fact that your investments will have a lot of safe and secure companies. Although the rule of owning mature companies is not set in stone, you should be able to make peace with the possibility.

The process used in dividend investing

Intuitively, the approach of dividend investing is, “Let me just see which companies pay out dividends and invest in them,” but the process is more involved than that. You want to pick a company that pays dividends, but you also want to know other things about the company besides its dividends. You want to know:

  • the performance of the company
  • how the company finances its dividend pay-outs
  • whether the dividend payments have been consistent or not
  • how much debt the company has, amongst other things

These are all important in your investment decision.

Risks of dividend investing

When using the dividend investing as a strategy, the main risk is that the company can choose not to make a dividend payment. There are several reasons the company could do this, but the decision does lie with them.

Another risk is called interest rate risk. In this case the investor asks: “Can I put my money in a low-risk savings account at a bank or do I risk my money in hopes of earning a higher dividend rate than the interest rate offered at a bank?” If the dividend payment rate is lower than the interest rate offered at a bank, then the investor is better off putting their money in a savings account to minimize risk.

The Momentum Investing Strategy

What it is

The momentum investing strategy is based on a concept called a trend. Just like the clothing trends and social media trends we see in our daily life, share prices can also trend. With clothing trends, for example, we know that in summer, shorts and sleeveless shirts may trend. Whereas in winter, it is usually jackets and socks that trend. Trends also exist in the world of companies.

In the world of companies, when there are more people buying a company’s shares than there are people selling, then the share price of a company increases. This is what we call a positively trending share price. It also works vice versa and is called a negatively trending share price. The momentum investor uses these trends to decide where to invest to make a profit.

The momentum investor believes in these words: “When the price of a company’s stock has been going up for a certain amount of time in the past, it is likely to going up in the future.”

The amount of time the stock will continue to go up in the future is unknown. A trend can last for a few days, months or even years. The momentum investor will simply stay invested until the company stock stops trending.

Momentum Investing

Personality of a momentum investor

The most important quality of a momentum investor is discipline. The momentum investing strategy is based on rules. The investor must set up rules that tell them which stocks to buy, and when to sell; and these rules must be followed religiously. Without discipline, this investment strategy would be an incorrect one to follow. The great thing about discipline is that a person can learn to be disciplined, as I once had to learn when I started investing.

A momentum investor should also be dynamic and aware. Since the investor does not know how long a trend will continue, they must be dynamic enough to change their mind should things not go their way and the trend stops. The investor should also be aware of herd behaviour and not go against the flow of the herd. Herd behaviour is when everyone is buying or selling the same stocks. The reason for this awareness of herd behaviour is that the herd is the one that causes the trending of different stocks, and going against the herd would mean not following the momentum investing strategy.

The process used in momentum investing

For momentum investing, you would use Technical AnalysisThis is a method of evaluating your investments and identifying trading opportunities using price trends and chart patterns. This is used because momentum investing is rules-based.

When you are a momentum investor, you look for shares prices that are increasing regularly and invest in them. When they stop increasing regularly, they have lost momentum, so you sell them and take your profits.

Risks of momentum investing

The main risk of momentum investing is the famous line: “Please remember that past performance may not be indicative of future results.” This means that just because a share price has been increasing recently, it does not mean that it will continue increasing. Since momentum investing depends on past performance to make predictions about a stock’s performance, you should be careful because past performance may not continue.

Sometimes, a momentum investor buys a stock that they believe is trending in a certain direction and the trend actually goes in the opposite direction that the investor predicted. This could result in losses for the investor.

In a nutshell…

That completes the introduction to both dividend investing and momentum investing. In my next article, “An introduction to Investing Strategies #3,” I will be discussing Sector Specific Investing and Factor Investing.

Image sources:

This article was written by Karabo Manasoe.

You can contact Karabo Manasoe by clicking on the social media buttons below, or by emailing him on: karabom@afrikakesho.co.za.

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Introduction to Investing Strategies #1

Afrika Kesho Blog Post on Introduction to Investing Strategies

 

There are many plans and back up plans you need to have in place as an investor – such as how you are going to allocate the capital you are investing, or how you are going to deal with life’s emergencies without selling your investments – one of the most fundamental plans to put in place is an investment strategy. After all, at some point or another, we’ve all heard the saying that it is often better to have a bad plan than no plan at all.

An investment strategy includes the behaviours, procedures, and rules that guide what stocks and other financial instruments you should buy. The type of person you are has some bearing on the appropriate investment strategy for you. If you tend to avoid risks in your daily life, it is a recommendation that you pick a safer strategy than one that may expose you to a lot of investment risk.

Although there are a lot of investing strategies you could use in your investing, the ones I am going to discuss in this article the two most traditional and philosophically different strategies: value investing and growth investing.

The Value Investing Strategy

What it is

The value investing strategy focuses on the concept of intrinsic value and perceived value of a stock or financial instrument. At times, a company’s stock may be perceived to have more value or less value on the JSE than it is worth in reality.

There are a number of reasons for this distortion in value, these include:

  • a growing or declining interest in the company by the public
  • good or bad news being broadcast or published about the company
  • bubbles in the stock market – when most stocks are extremely overvalued by the public
  • stock markets crashes – when most stocks are extremely undervalued by the public

What this information about value distortions says to the value investor is: buy stocks whose price on the JSE is less than the true value of the company, called undervaluing the stock; and sell stocks whose price on the JSE is more than the true value of the company, called overvaluing the stock.

value

The personality of a value investor

As a value investor you are constantly on the lookout for stocks that are undervalued on the JSE. You believe that these overreactions by other investors on the market that cause the perceived value of a company to decrease, is a good opportunity to purchase the stocks. When a company is undervalue it is practically on sale – you are buying at a discounted price. Most of us are familiar with the concept of an item being on sale: however much the price of an item was before the item went on sale does not matter, all we know is that we can get the same item for cheaper now.

Other qualities possessed by the value investor is the ability to avoid herd mentality and maintain a long-term view about the true value of a company. As a value investor, when the herd causes the price of a stock to decline, you may choose to buy the stock instead. This is because you determine the company’s true value by analysing the company’s financial information, you believe that in the long-term the herd will begin to realise the true value of the company and join you in your buying. By the time the herd buys, you will earn yourself a handsome return because a company’s share price increases with more demand for the stock, and since you bought at a bargain you stand to gain more when the price of the company stock increases.

The process used in value investing

Just as is the case with all investing strategies, value investing requires doing the work to find which stocks are on sale in the stock market. The process which may be employed to achieve this is Fundamental Analysis; a topic I will write about in future. For now, you can use this intrinsic value calculator by buffettsbooks.com.

The risks involved

Value investing does have risks, and these may stem from the investor being wrong about the true value of the stock and therefore being on the wrong side of the investment. These risks include incorrectly applying the fundamental analysis process and overlooking some important information about the company.

The Growth Investing Strategy

What it is

The growth investing strategy focuses on, as the name says, growth. You get growth by looking for companies that you think are growing a lot, well, their share price is growing a lot. In technical terms, you are increasing your capital through the purchasing of stocks whose earnings performance is expected to be above benchmarks within the industry the company operates in or the entire stock market. But, I’m trying not to be too technical. The nature of these companies is usually young and small companies, the name often used to describe them them is “growth stocks”. This is because small companies have the potential to become big companies, and in that process, they grow. Big companies usually have very little room for growth.

When a company gets access to some technology that helps them do their business more efficiently, they gain a competitive advantage. Such a company may have a share price increase on the JSE because of the new growth potential in the company brought about by the new technology. Believing in this growth of the company and its increased earnings in future, the growth investor will purchase shares in that company. The capital appreciation (increase) sought by the growth investor does not always have to be long term, the appreciation can also be short-term in nature.

growth

Personality of the growth investor

A growth investor must be forward looking. The investor will typically consider the industry that the company operates in. If the industry does not have a great outlook for whatever reason, then the stock may not be considered one worth buying. A growth stock should be doing as the name suggests, it should grow.

Another personality trait that the growth investor needs is the ability of self-sacrifice. This is because growth stocks don’t usually pay dividends to their investors, especially since the company is usually small or newly listed on the JSE. Growth companies usually reinvest their profits into the business, and that would be where the growth typically comes from. It is important to note that if the company does remain consistent in beating growth expectations, the capital appreciation will make up for the lack of dividends.

The process used in Growth Investing

Growth investing does also require application of fundamental analysis, including the monitoring of management of the company you are looking at. “Management” is the grouping of all the top officials in a company, including the CEO, CFO and the rest of them, and is an important consideration since incompetent management can be the downfall of a company, leading to loss of money for the investor because of the declining company value (as opposed to growth).

The risks involved

Because small companies have fewer resources, they are more affected by negative publicity, bubbles and market crashes. This means that small companies have share prices that are more volatile – they move up and down a lot. This high volatility may cause losses if you find yourself in the wrong side of a price spike. The company not paying dividends to its investors may also be considered a risk.

There is also the concept of premium prices: If you pay more for a stock than you believe it is worth, then you’re buying at a premium. You are buying an overvalued stock. When you buy a stock at a premium, the risk is that the price falls back to the company’s true value, which would also result in a loss for you.

In a nutshell…

That completes the introduction to both value investing and growth investing. In my next article, “An introduction to Investing Strategies #2,” I will be discussing Momentum Investing and Dividend Investing.

Image sources:

  • http://www.valuewalk.com/2017/02/buffett-series-value-investing/
  • https://www.vicarea.com/growth/

 

This article was written by Karabo Manasoe.

You can contact Karabo Manasoe by clicking on the social media buttons below, or by emailing him on: karabom@afrikakesho.co.za.

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How to choose a stockbroker

What a stockbroker is

As people, we know that the products we buy from our local stores are not manufactured at the store itself. Rather, these products are produced and imported from elsewhere and then sold to us. We can then give our local store the title of “middleman”; the store connects us with the original producer of the product. The same concept applies with investing on the JSE, you need a middleman to buy and sell shares or any of the other financial products. The official term for the middleman in financial terms is called a stockbroker.

Anybody, including large financial institutions like banks, must go through a stockbroker to buy shares and other financial products on the JSE. However, banks generally have in-house stockbrokers for convenience. Traditionally, a stockbroker was an actual person, but with the advancement of technology, this has shifted. Companies that are registered with the Financial Sector Conduct Authority (FSCA)  (they changed from being the Financial Services Board [FSB]) and the JSE can offer stockbroker capabilities through their online platforms without the physical involvement of a person.

For those not familiar with the Johannesburg Stock Exchange (JSE), in simple terms, it is a market that sells shares and other financial products.

What you need to know when choosing a stockbroker

Like how you can choose the store where you buy goods, you have several options with regards to what kind of stockbroker you want. For example, your current bank can be your stockbroker, you can hire an individual registered with the FSCA and the JSE, or you can use online platforms that are similarly registered. Depending on where you are in your investing journey, there are important factors you need to consider when choosing a stockbroker. After all, not all stockbrokers are created equal.

You should make your decision on which stockbroker you want to work with carefully, here are some of the things you should take note of:

  1. The level of involvement you want from your broker

You could choose a broker whose sole purpose is to enable you to transact on the JSE. Their function ends there and does not extend to suggesting what you should buy or sell on the JSE. This type of broker is known as an execution-only stockbroker. You usually choose an execution-only broker when you want to do stock-picking yourself, with no external help from your broker whatsoever.

On the other end, is an advisory broker. This type of broker will not only enable you to transact on the JSE but will also make suggestions on which stocks or other financial instruments to buy. To make these recommendations, these companies use either research the stockbroker company has done by themselves, or the research they got from other institutions.

You could go so far as having an advisory broker that will completely manage your investments, without any input from you whatsoever.

  1. Fees! Fees! Fees!

Price always matters. So, one of the things you should consider is how much you’re willing to pay, and how much you can afford to pay. An advisory broker, given that they dedicate many hours to conducting the research for their recommendations or money for the research if it is outsourced, will most likely charge your more on fees than an execution-only broker, who does not provide any recommendations. Your bank would also likely charge you less than an individual broker. When you decide on a stockbroker, consider the size of your investments i.e. how much money you have. If you can afford more, you are welcome to pay more.

  1. The type of investor you want to be

The other important question when choosing a stockbroker is: “What am I trying to achieve by investing?” The answer to this question will determine the type of broker that you need.

If you decide that you’ll be going fully DIY in your investing and want minimal advice from your broker, the appropriate choice for you will likely be an execution-only broker. If you need assistance with some or all of your investment decisions, reason being the calming effect provided by leaving the nitty-gritty work of research to a professional, then you’ll want an advisory broker.

Find your investment style and match it with the kind of stockbroker you want.

The above factors for choosing a stockbroker are not an exhaustive list of factors to consider, everyone has unique circumstances that may bring other factors not listed into play. So, look at your current circumstances and use your full discretion in choosing a stockbroker.

The broker I use

I use Easy Equities as my stockbroker. I discovered them while I was listening to an episode of The Fat Wallet Show by JustOneLap.com, and I haven’t turned back since! I feel that they have revolutionized the investing world by allowing the average Joe such as myself to invest on the JSE.

I am a fully “DIY” investor, I do my own research and make my own stock picks, and the broker I use allows for that, and it’s easy to use. Because I’m a DIY investor, I want very little involvement from my stockbroker.

One of my philosophies when it comes to investing is to cut fees wherever and whenever possible, so that I have more money for my actual investments. As far as I know, Easy Equities is the cheapest and easiest online stockbroker there is. In that sense, they are the most suitable stockbroker for me.

Other available stockbrokers

Easy Equities is not the only online broker available out there, there are others, with different levels of difficulty, pros and cons, and fees.

Below is a link to Easy Equities, as well as links to other online stockbrokers, check them out and begin your investment journey:

  1. Easy Equities – http://bit.ly/2RicK4V

  2. Standard Bank Online Share Trading – https://securities.standardbank.co.za

  3. Rand Swiss – https://www.randswiss.com

  4. Absa Stockbrokers and Portfolio Management – http://www.absastockbrokers.co.za

  5. Sanlam Private Wealth – https://sanlamprivatewealth.sanlam.com

  6. PSG Wealth – https://www.psg.co.za/wealth

This list is by no means comprehensive, you are encouraged to do more research on other stockbrokers. Intellidex, https://www.intellidex.co.za/,  is the best place to start with your research. They provide various reports on capital markets, including an annual list of stockbrokers who stood out in a particular category.

The Easy Equities link is an affiliate link, you’ll get R50 from Easy Equities to get you started on your investment journey.

Happy investing!

This article was written by Tumelo Koko.

You can contact Tumelo Koko by clicking on the social media buttons below, or by emailing him on: tumelo@afrikakesho.co.za.

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