Questions you should ask before investing

Do not depend on the advertisement of the investment product or on social media chatter and promises of huge returns.

Choosing an investment product can be like grocery shopping. Lots of products with lots of fancy packaging.

As an investor, you need to look beyond the packaging and read the composition of ingredients used to make a product.

The capital market landscape in Kenya is changing daily and intending investors need to be sufficiently informed about investment products before spending their money.

The following questions will help investors make a proper investment choice:

Is the Investment Licensed in Kenya?

Every market participant in the Kenyan capital market whether primary or secondary has to be licensed by the regulatory body which is the Capital markets Authority, CMA.

As an intending investor, you should get the name of your broker or dealer/investment provider and head to the CMA website to check the list of licensees to see if your broker is legitimate.

Trading participants such as brokers, dealers etc. must satisfy all CMA requirements before they are deemed “fit and proper” to do business in Kenya. This is not bureaucracy but is so for the protection of the investor from scam brokers.

What are the Benefits of dealing with a licensed market participant?

Investor compensation fund

The Investor Compensation Fund (ICF) is a fund set up by CMA to compensate any investor who suffers erosion of funds due to system glitches or negligence by a trading participant while carrying out their duties.

As per law, the Investor can receive a maximum compensation amount of Kes. 50,000.

The investor is compensated when the reason for the loss of funds is not his. Dealing with a licensed firm means you qualify for compensation from the ICF.

Transparency and fair trade

When you do business with a licensed firm you can rest assured you will not be cheated and your trades will be executed as at when due and with your best interest at heart.

This is because the CMA monitors everything the licensed members do and has the statutory powers to intervene & carry out disciplinary action in case there is some dispute, to ensure fair dealing by its members.

How Does the Investment Instrument Work?

The capital market in Kenya is saturated with various types of financial products from simple ones like debt instruments to complex ones like derivatives.

Whichever you choose to invest in, you need to take out time to study it and know what you are getting yourself into.

Is what you see what you get?

Do not depend on the advertisement of the investment product or on social media chatter and promises of huge returns. Most times these investment products are marketed as one thing and end up being another.

When scrutinizing an investment product always know that they could either be simple products or, complex products.

Simple Investment Instruments

They don’t depend on any other asset to derive their value and they are pretty straightforward. Some examples in Kenya are

1. Treasury Bonds

Issued on a monthly basis in Kenya & interest paid every six months till maturity, they are debt instruments used by the government to raise additional funds to finance projects. In Kenya, fixed coupon bonds enjoy a lot of popularity.

 They can be bought through the primary market from banks and financial institutions or via the Nairobi securities exchange. You need Kes. 50,000 and above in order to acquire bonds in Kenya. These are considered low-risk investments as they are backed by the Government.

2. Corporate Bonds

When a private sector organization/company wants to raise funds without selling their shares, they issue bonds to the public.

3. Collective Investment Schemes (CISs)

They pool resources together from various investors to invest in a particular asset. The investor is allotted shares from the CIS as proof of his/her investment and is paid dividends.

As seen on the CMA website, there are 29 licensed CIS in Kenya.

4. Stocks / Equity/Shares

When you buy shares of a company, you become a part owner of the company. Shares can be bought from the primary market (through initial public offers) or secondary market (Through the Nairobi Securities Exchange).

A dividend is generally paid to the shareholders at the end of every business year, although the companies could decide not the pay any dividends.

There are 63 companies trading on the Nairobi securities exchange & investors can invest in these companies via authorized Stock Brokers.

5. Preference shares

Ever heard the term “ordinary shares”? Well, preference shares are like ordinary shares but with preference to its holders.

Preference shares are superior to ordinary shares and have some unique features like dividends are paid to preference shareholders first and in case the company goes bankrupt; preference shareholders are compensated first before ordinary shareholders.

6. Loan stocks

If a company takes a loan, it may choose to use its shares as collateral. In a case like this, you may choose to buy the shares and benefit from the dividend till the loan is fully repaid.

If the shares are publicly traded then the lenders can easily sell these shares for cash.

7. Real Estate Investment Scheme (REIT)

If you want to benefit from the Real Estate business without really owning a house, then this instrument is for you.

In Kenya, two types of REIT are in play, Development REIT (D-REIT) and Income REIT (i-REIT). REIT companies build houses, apartment complexes, hotels etc. and pay dividends to shareholders from the rent and income generated.

The CMA website has published two authorized i-REIT companies and one D-REIT Company operating in Kenya.

Complex Investment Instruments

Complex investment instruments have more complexity than simply instruments. These are riskier but have the potential for higher returns.

Derivatives

Derivatives are considered Complex Instruments & are not suitable for Common Investors. They depend on one or a group of underlying assets, to get their Value. The assets could be interest rates, commodities like gold, exchange rates etc. They include

  • Forward Contracts: An agreement between two parties to buy or sell an asset at a given date and for a given price. Settled over the counter (OTC), it can’t be traded on the Nairobi securities exchange.
  • Futures Contracts: This is an exchange-traded version of a forward contract.
  • Option Contracts: The holder of an option has the right but not an obligation to buy or sell an asset at an agreed price and time.
  • Swaps: This is when two financial instruments are swapped at an agreed time and under agreed conditions. Interest rate swaps and currency swaps are the most commonly traded.

Asset-Backed Securities

This type of instrument has to do with grouping different types of loans together into a basket and creating a security out of it.

Investors buy into the security and profit from the proceeds of interest earned on the loan.

Take your time to completely understand the instrument in which you are investing. Learn about the risks involved & their complexity.

What Are the Risks?

When trading, you are faced with two possible outcomes, win or loss. You may want to decide how much money you are willing to lose if things do not go as planned.

For example, in Forex Trading, Kenyan traders can trade using the leverage of up to 1:400. The six CMA licensed non-dealing forex brokers in Kenya namely FXPesa, HotForex Kenya, Pepperstone, Scope Markets, Exinity Limited offer margin trading on forex & CFDs with leverage as high as 1:400.

With leverage, you are trading using margin offered by the broker & it is classified as a complex product. This amplifies your risk & you could lose your money quickly in a single trade if you are not careful.

You should fully understand the risks of the instruments that they are trading or investing in.

When you decide on how much you are willing to lose, you can use safety mechanisms such as stop-loss orders and stop-limit orders. They let you set an automated loss level so the system closes your position when that limit is reached.

You should remember that Complex Instruments are riskier than simple instruments. Also, instruments that have higher returns are riskier.

What is the Maturity Period of the Investment?

Choosing an investment product should be based on the goal you want to achieve. 

Short Term Investments are investments made for a period of a few months but can be for a few years.

Like fixed deposits which can have a typical term of 12 months, have the benefit of being more liquid as you can access your funds easily. Their drawback is that their return on investment is generally low as you have not given it enough time to mature.

Short Term Investments which are usually those held for a few months could be for goals like saving for a wedding or going on a vacation.

Long Term Investments are normally for a period of a few years. Like investing in equity/shares can be more profitable because the shares in good companies generally appreciate with time. Companies that start small may grow into more valuable companies.

You could also invest long term in Treasury Bonds. Investing in Equities is generally riskier than Government bonds.

Long term investments are ideal for goals like buying a house, school fees fund etc.

What are the Transaction Charges Involved?

When most investment instruments are advertised, they don’t fully educate the investors on the complete list of charges that may apply.

Instruments traded on exchange usually have certain charges and fees. For example, in intraday trading especially, the brokers charge fees for everything and the more complex the instrument, the more the fees.  

The regulators also intervene to keep the charges reasonable. The NSE had reviewed intraday trading charges downward to encourage traders.

An investor should also find out if there are charges on early liquidation of the investment. This is important because some circumstances may warrant you to terminate the investment and get back your money. You need to know if that is possible and if there is any penalty for doing so.

By: Emmanuel B.

Content provided by Forex Beginner.

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