Technical Savings and Investments Information

INVESTMENTS

Since the value of an investment-linked long term insurance policy depends on the performance of its underlying investment portfolio, in order to fully understand its nature, it is necessary to have a basic knowledge of investment.

RISK OF INVESTMENT

What motivates a person to invest, rather than spending their money immediately? The most common answer is accumulation of wealth and provision for the future. To increase wealth, a person needs to do something to the savings to make them grow. What a person does with the savings to make them increase over time is investment. Thus, investment is the commitment of money for a period of time in order to derive larger future payments.

The definition of investment is to sacrifice present value for future value.  When we talk about investment, most people focus on how much money they can make without any detailed analysis or are even ignorant of the risks involved in the investment. It is imperative for investment advisors to fully understand the concept of risk and help investors define their risk appetite before embarking on investment or giving investment advice. Therefore, we start with a detailed look at risk.

Meaning of Risk

Risk is the possibility of loss or injury. In investment terms, it is the uncertainty associated with the end-of-period value of the investment. Investors are however, more concerned with the downside risk, which represents the possible loss or reduction of the original sum invested – financial risk. In the investment industry, the existence of financial risk means that it is possible for investors to lose money, and that there is no absolute guarantee of capital growth.

Financial risk is often perceived to have increased in recent years. The equity market crash in 1987, the Sterling Pound's exit from the Euro Exchange Rate Mechanism in 1992, the bursting of the bond market bubble in 1994, the Asian markets meltdown in 1997-1998, the 911 terrorists attack in 2001, the SARS and more recently the Financial Tsunami, have all left their marks in the minds of investors. This perceived increase in financial risk, together with a growing awareness among investors of the various techniques and products for managing it, has led to a sharp increase in demand for risk management services.

Types of Risks

Investors are sometimes mistaken by the concept that they can avoid risks by just placing their asset in a bank account. This act however, is still subject to two risks:

- default risk in that the bank they invest in may go out of business; and
- inflation risk in that higher prices of goods in the future will reduce the purchasing power of the saved funds.

There is an endless list of risk factors in investment to the average investors. The following list covers the more common and important risks:

• Market risk – basic demand and supply in the market will affect the price of investment instruments. An investor will suffer a loss if he/she has to sell an asset when the price drops below his/her original purchase price.
• Company risk – negative developments such as the loss of market share or the failure of a new product launch will have an adverse effect on a company’s financial status and thus its share price.
• Economic risk – the possible impact of an overall economic slowdown.
• Inflation risk – the loss of purchasing power as return on investment does not match the inflation rate.
• Default (credit) risk – the potential inability of a debt issuer to pay interest and/or repay principal. 
• Interest rate (price) risk – the price fluctuation of certain fixed income investments prior to maturity due to current market interest rate changes. 
• Liquidity risk – the inability to liquidate (sell) an investment or the need to pay a substantial cost to liquidate. 
• Reinvestment-rate risk – the inability to reinvest interim cash flows or a mature investment at the same or higher rate of return. 
• Exchange (currency) risk – a foreign financial investment upon maturity may have to be converted into home currency at a less favourable rate due to foreign exchange rate fluctuation. 
• Sovereign or Political risk – political instability may cause governments to take actions that are detrimental to the financial interest of financial investment instruments in that country. 
• Operational risk – the risk faced by financial institution arising from the operations of the business deal processing, deficiency of information system, ineffective internal management and control system, human errors, etc.