The 50,000 Bob Problem: Part 1

“I have 50,000 bob, where can I invest it for one year and make good returns, without risking the money?”

That was my gadgets loving friend asking over Gtalk. For some reason, we don’t like to ask money questions face to face.  His question is The 50,000 Bob Problem: You have made some money, too much to waste, just the right amount for the latest gadget (maybe the version before the latest one) and too little to buy an apartment. What do you do with your 50,000 bob?

In the next couple of posts, we’ll discuss the various investment options for the 50,000 bob guy, and I challenge you to  give your opinion, critique the options and give the guy helpful suggestions in the comments section.

“What do you mean by good returns?”

It’s good to define your investment goals beforehand. “Good Returns” doesn’t tell us much, it’s good to quantify your returns. For example, do you want a 12% return, or a 50% return? Do you want to make returns that will be sufficient to buy you the next iPad when it’s released in April 2013?

As you define your investment goals, bear in mind the 5^th Law of Gold:

“Gold flees the man who would force it to impossible earnings or who followeth the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment. “ (From the Richest Man in Babylon)

Your goals have to be realistic, otherwise you will be disappointed. Does this rule out the possibility of doubling your money in a year? Well you could get lucky, and luck is good. I however advise people to plan realistically, if luck finds you along the way, then well and good.

The Risk Element

Risk is part of life. Whenever you’re dealing with money, you’re exposed to the risk of losing some of it, even if you choose to store your money under the pillow. The following three risks are the most important when considering investment options:

1.  Inflation Risk: This is the risk that over time, your money will lose its purchasing power. In Kenya for example, this is a real risk. Last year alone, the Kenya Shilling lost about 17% of its purchasing power. What this means is if you kept your 100 bob in your pillow account for all of last year, today, it’s lost 17 bob worth of value. Experts estimate our long term inflation rate to be about 7% per annum. However, this rate is only important if our guy is willing to invest over a long period (over 5 years). With a 1 year investment period, 17% is the figure to watch, if he is in Kenya.
2. Investment Risk: This is the risk that you will lose all your money. Investments follow one simple rule: More Risk, More Return.  I wanted to give the Pyramid Schemes example on this, but on this blog, we don’t consider pyramid schemes a valid investment channel. Investing in government securities for example is considered an almost zero risk option, because the risk that the government will default on its obligations is low (this risk is never zero though, governments go bankrupt too). For that reason, government securities will pay a low rate of return (between 8% and a high of 23% last year). The stock market on the other hand is considered a fairly risky investment channel. You can double your money or lose most of it in the stock market.
3.  Liquidity Risk: This is the risk that you will not be able to convert your investment into cash when a need to do so arises. For example, real estate is considered fairly illiquid. The average land selling transaction will take 90 days. Bank deposits are on the other hand considered very liquid; you can access your cash readily. As it follows, the more liquid an investment, the lower the rate of return. Banks for example will pay as low as 2% on savings accounts.

Next on the 50,000 Bob Problem:

Photo Credit: Ambro

“Ok, I really don’t like what I’m hearing so far, and since the iPad 2 is now cheaper, I’d rather just buy that instead of investing all year just to make 6,000 bob return.”

I advised the my gadget loving friend to put the money in a SACCO, take a 1 year loan for the full amount and use it to buy his iPad 2 instead. Check the next post to see why I’d give such atrocious advice…

Photos credit