Sunday, July 15, 2012

Risk-Free Rate AND Investment in Equities

What is Risk-Free Rate ("RFR")?


In Malaysia, RFR usually refers to Fixed Deposit ("FD") Rate, currently about 3.00% p.a.


However, FD is not totally Risk Free if you place more than RM250,000 with a bank (PIDM-Deposit Insurance), thus making anything above RM250,000 not risk-free. If you have RM2 million, you need to place RM250,000 with 8 banks, in order to enjoy "risk-free" status.


Well, what is RFR to do with Investment?


Every Investment involves certain degree of RISK. Therefore, it is only logical to invest with the investment generate above and beyond the RFR.


The higher the potential risk, the higher the ROI (Return on Investment) must be as compared to RFR.


I would prefer to invest in a company with Dividend Yield of at least 6% (with high certainty on the consistency) as compared to a company where no dividend or low dividend yield.


Investment in Gold gives you 0% yield, thus dangerous as it solely depends on the 'hope' that the gold price will goes up. No yield, you can not enjoy the benefit of "compound interest" - the 8th Wonder by Albert Einstein.


Investment in Property may also gives you much lower than RFR (as property price is at all time high now) and therefore one may have to seriously consider the asset allocation (i.e. how to allocate our limited resources effectively).


Example: If a condominium unit generate a 3% rental yield (Gross Rental / Market Value), then the owner should consider to dispose it as.........


1. Property price may not always up (supply vs demand)
2. Rental Yield of 3% is gross, after deducting for expenses and income tax, you may ended up with only 2% or lesser.
3. There is always a risk where the property price may go down due to reasons beyond our control.
4. Likely to continue appreciate??