Chapter 3 Personal Investment Instrument
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This document provides an overview of Islamic financial planning and various investment instruments. It discusses categories of investment such as financial assets vs real assets, and high/low risk short/long term direct/indirect investments. Various types of investments are explained in brief, including savings accounts, fixed deposits, shares, bonds, properties, and funds. Key concepts around risk and return in investment are also summarized such as risk-return tradeoff, diversification, and different types of risk.
Chapter 3 Personal Investment Instrument
- 1. ISLAMIC FINANCIAL PLANNING Mahyuddin Khalid Personal Investment Instruments
- 2. Chapter Outlines Content Investment Categories of Investment Return and Risk in Investment Type of Investment • Investment in Savings Account • Investment in Fixed Deposits • Investment in Shares • Investment in Bonds • Investment in Properties • Investment in Funds 2
- 3. Introduction Financial planning involved a decision on how individual create and accumulate more wealth. Muslims are encouraged to create more wealth to meet their darurriyat, hajiyyat and tahsiniyyat needs. Investment are activities involved by a person to increase it’s a assets value. Ultimate aim of investing is to achieve a positive income and/or preserve or increase its value. 3
- 4. Investment The Process of Investment Management Financial Status, needs, and personal characteristics What is investment? Risk taking financial activities perform by an individual or companies with the expectation for a positive changes in the value of their principal amount. 4
- 5. Categories of Investment Financial assets or real assets High or low risk Short or long term Direct or indirect Debt or ownership 5
- 6. Your financial plan? Asset allocation Decide your own financial objectives Diversification Risk tolerance Investment return 6
- 7. Risk and Return What is risk? • Uncertainty - the possibility that the actual return may differ from the expected return • Probability - the chance of something occurring • Expected Returns - the sum of possible returns times the probability of each return Risk, from a finance viewpoint, refers to the uncertainties associated with returns from an investment • These uncertainties would translate into volatility or fluctuation of returns from an investment. • Measured by standard deviation. • Gains & losses, “upside” potential & “downside” possibility 7
- 8. Risk Profile in Investment •Affects income returnInterest Rate Risk •Overall market effects (politic, economic and social)Market Risk •Purchasing power variabilityInflation Risk •Ability to liquidate investment convenientlyLiquidity Risk •Investment earning and ability to pay the return (interest, principle, dividend)Business Risk (non-systematic) •Payment attributable to the mix of debt and equity to finance business (Default, Liquidity, Marketability, Leverage)Financial Risk •Changes in code, treatment, fluctuationExchange Rate/Currency/Tax Risk •Failure to comply with the Shariah rules and principles in investmentShariah Non-Compliance Risk 8
- 9. Risk-Return Trade-off Risk-Return Trade-off •The risk-return trade-off is the principle that potential return rises with an increase in risk. •Low levels of uncertainty or risk are associated with low potential returns, whereas high levels of uncertainty or risk are associated with high potential returns. •According to the risk-return trade-off, invested money can render higher profits only if the investor is willing to accept the possibility of losses. •For investors, the risk-return trade-off is one of the essential components of each investment decision as well as in the assessment of portfolios as a whole. 9
- 10. Investment Instrument Equities • (i.e. common shares) Fixed income securities • (i.e. bonds and sukuk) Investment funds • (i.e. unit trust, ETF, REITs) Tangibles • (i.e. properties) Derivatives • (i.e. forward, futures) 10
- 11. Types of Investment Investment in Savings Account Investment in Fixed Deposits Investment in Shares Investment in Bonds Investment in Properties Investment in Funds 11
- 12. Saving Account Accounts maintained by retail financial institutions that pay interest but can not be used directly as money (for example, by writing a cheque). This saving account under Al-Wadiah Yad Dhamanah. Bank accept deposits from customers looking for safe custody of their funds and at the same time the customers are able to withdraw their money at any amount at any time. These accounts let customers set aside a portion of their liquid assets while earning a monetary return. Types of saving account: Individual saving account Joint saving account Saving account for associations, societies and clubs 12
- 13. Why Is Saving Account Necessary? These are the reasons why you should open a savings account if you do not yet have one. Provide you with a safe place where you can store your money. Savings accounts provide you with PIDM insurance. Savings accounts allow you to earn profit. 13
- 14. Interest on Saving Account Profit rate on saving account is calculated on the account’s outstanding balance at end of each day. The profit is credited to the account every 6 months, that is on June 30 and December 31 each year. Formula used to calculate interest using simple interest Interest amount = Principal x Time x Rate Principal: balance at the end of each day of the month Time : 1/365 14
- 15. How do saving account works? When you put your money into a savings account, it earns interest, so bank can use your money to fund loans for other people. Actually it works like this: Open a savings account at the bank. The bank pays interest on the money that you deposit and leave in that account. Bank loans that money out to other people, charge a slightly higher interest rate on the loan than what they pay you for your account. 15
- 16. Advantages of Saving Account Advantages: Most basic account Simple Procedures - Photostat IC front and back and be present at the bank. Low initial deposit to open an account Disdvantages: Low returns - Negligible Troublesome to withdraw money For ATM card service there is a charge of RM 8 annual fees for all banks in Malaysia. 16
- 17. Investing in Fixed Deposit Using Mudharabah contract No interestPayment of profit is under discretion of Islamic banks No interest paid on 1, 2, or 3 month No interest paid on FD of 4 month and above Rate payable for FD withdrawn before maturity is half the contracted rate Fixed Deposit can be opened by: Individual aged 18 years and above Joint individual Societies Associations and clubs Companies 17
- 18. Investment in Shares Characteristics of Common stock • Right to residual value of the firm • Right to the portions of dividends if announced • Right to vote in the AGM. Common Stock Dividend • Cash: Treated as investment income and taxable • Stock: Dividend in form of additional stock issued in proportion of stock owned • Property: Dividend in form of product and services Equity instruments represent ownership in the company.Common stock is • A public listed company is jointly owned by its shareholders. • Since the corporation is a separate legal entity the shareholder is responsible for any losses up to his total investment. 18
- 19. Advantages of Investing in Common Stock Advantages of investing in Common stock • High current income • Higher rate of return • Low unit cost • Less risky due to its position during liquidation Disadvantages of investing in Common stock • Return is limited and fixed in amount • Capital gain potential is small • Yield give-up relative to bond • Yield not kept up with inflation 19
- 20. Why invest in stocks? Wide range of choices. Immediate buy/sell at any time. Low transaction cost. Easy to monitor. Ability to maximize return whilst spreading risk. Freedom to work at your own place. Managed by professional managers. 20
- 21. Investment in Bonds/ Sukuk Definition Long term debt instrument issued by a corporation either public or private to finance the company’s long term assets. The issuer has to make periodic interest payments to the bondholder who is also known as the buyer at the maturity. 21
- 22. Bonds from Shariah Perspective Securities representing a loan or debt (such as bonds) cannot be sold or purchased. If they are sold at a price higher or lower than their face value, it is considered as “Riba” If they are purchased at their face value (Bai al-Dayn), this involves “Gharar” and hence prohibited. However, securities may be assigned to a third party at par value. The difference between sale and assignment (al-hawalah) is that transfer in al-hawalah is with recourse while transfer in sales in without recourse. 22
- 23. Characteristic of bonds Par value • Par value in malaysia is RM 1000 • Selling at discount if it is sold below RM 1000 • Selling at premium if it is sold above RM 1000 Coupon rate • The percentage of the par value of the bond that will be paid out periodically in the form of interest Maturity period • The maturity period is between 10 to 30 years Claims on asset • Bondholders will be the first to receive the firm’s asset before the preferred stockholder if the firm is declared bankrupt Voting right and fixed income • Receives fixed income in terms of coupon rate, which is predictable and regular income • Has no voting right 23
- 24. Sukuk vs. Bonds Bond Item Sukuk Short, Medium and Long Term Tenor Short and Med-Term (≤5 yrs) Debt Financing Category No debt but ownership of specific asset and its cash flows Not necessary, unless collateralized Underlying Necessary underlying asset, usually tangible asset Fixed in time, and amount Claim Ownership claim on specific asset and its cash- flows Depends on rating, yield environment and demand (book- building) Pricing Use of indicative yields- benchmarked on reference rates Fixed income (known/predetermined cash flows) Total Returns No guarantee in returns Unrestricted Funding Purpose Restricted for use in Shariah compliant assets, in a 24
- 25. Property Investment Property investment is where investor make a small investment into a property, then go on to rent it out to cover mortgage repayments, Once raised in price, sell it, or remortgage to acquire the finance tax free, thus gaining a profit or to purchase more property. 25
- 26. Types of Property Residential House Shop Houses Standard Lots In Shopping or Office Complex Condominium Flats 26
- 27. Important Part in Property Investment It less volatiles compared to equity Asians like physical assets due to less development investment market Government bonds are not readily available to small investor Opportunities for growth due to stage development in economic and society Still perceive the intrinsic values of properties 27
- 28. Factor to consider when investing • How much • % Funds • Determine the value • Strategic place Location • Track of record • Good decision Developer • Structure of properties • Example: cracks or leaks in the wall Physical condition • Example: • public transport, markets, shopping mall, car park, Infrastructure • Loans • Banks Sources of findings To evaluate the real estate cycle or the timing of entry and also exit 28
- 29. Factors that Influence Return Population Growth Scarcity of land Income Growth Economic Activities Supply and Demand Speculation 29
- 30. Investment Fund AAOIFI define Investment fund as Funds are investment vehicles •Which are financially independent of the institutions that establish them. Funds take the form of equal participating shares/units •Which represent the shareholders’/unitholders’ share of the assets, •Entitled to profits or losses. The funds are managed on the basis of either mudharabah or wakalah (agency )contract 30
- 31. Investment in Unit Trust One important feature of unit trust is that professional fund managers are employed to manage the funds. • They are highly qualified and experienced in investments. • It is done at minimal cost, minimizing, liquidity, and capital appreciation Investors money will be pooled together to be invested in a single diversified investment portfolio which comprise stocks, bonds and others in accordance with the investment objective. Unit Trust investment offers a reasonable amount of return with minimal risk. 31
- 32. Key Differences between Islamic and Conventional Funds Investible Universe Purification Role of Shariah Advisor Fee structure 32
- 33. Types of Funds by Investment Portfolio Equity Funds Fixed Income Funds Money Market Funds Balanced Funds Islamic/ Shariah Funds Sukuk Funds Real Estate Investment Trust Funds Exchange Traded Funds 33
- 34. Types of Funds TYPES OBJECTIVES STRUCTURE/UNDERLIER Money Market Funds To invest in money market. Short term debt instrument, mostly treasury bills Income Funds To provide current income on a steady basis. Government and corporate debt, stocks and bonds Balance Funds To provide a balance mixture of safety, income and capital appreciation. Mixture of fixed incomes and equity Index Funds To replicate the performance of a broad market index. Market Index Investment-Linked Funds To provide balanced income for specific life insurance or family takaful plans. Stock and bonds 34
- 35. Advantages of Unit Trust Many investors lack sufficient resources to establish an adequate diversification on their own. Diversification Different types of funds are created for different investment objectives. So investors should have no problem finding funds that meet their objectives in terms of return and risk Funds with variety of objectives The management company maintains and administers the records of shareholder’s activity for a given year. This is a great convenience for the investors. Record keeping services. Fund managers who are knowledgeable about investment and they have good track records of performance, high integrity, etc. Professional management Unit trust can be bought and sold easily. Thus they do not suffer from liquidity risk. High liquidity Only a small amount of money is needed to participate in a portfolio of investment which enjoys the same benefits as in direct investment which requires large amount capital. Affordability 35
- 36. Mahyuddin Khalid 36 End of Chapter Personal Investment Instruments