Commodities

In a previous post I talked about how there are many different investment opportunities out there. I talked about how there are hundreds and thousands of different investment brochures and pamphlets. They are all different colours and shapes and sizes. This of course can be very overwhelming if you are not used to this kind of literature.

What you have to remember is that there is only basically six asset classes in which you can invest your money. I would like to talk about one of those asset classes today, that is the commodities class.

Commodities are your basic food or raw materials. Of the top of my head i can think of cotton, gold, pork bellies (still don't know what that means) and of course oil. If you have seen the movie starring Dan Akroyd and Eddie Murphy called Trading Places you may think frozen concentrated orange juice is a commodity but I'm pretty sure it is not traded anywhere although I stand to be corrected.

Commodities can be divided into seven categories:

1. grains and feeds (barley, bran, corn)
2. foods (butter, cheddar cheese, cocoa, eggs, sugar)
3. fats and oils (coconut oil, lard, palm oil)
4. fibres and textiles (cotton, wool)
5. Metals (aluminum, copper, steal)
6. miscellaneous (rubber)
7. precious metals (gold, silver)

By all means think about having commodities as part of your portfolio but don't make that the focus or put 100% of it in commodities you could be heading for disaster. Commodities are great for 10% of your total portfolio.

What is private equity?

Private equity is a general term for raising private money to invest in business ventures. I always make the example of if your brother or sister decide to open a corner fish and chip shop and you give them some money to start the venture then this could be considered private equity.

So, who invests in private equity? Usually high net worth individuals, pension funds, banks, insurance companies and other institutional investors invest in private equity. The minimum investment in private equity are generally quite high so it is out of reach of the average investor.

What happens after you give your money? The venture capital firm that is looking after the investment will pool all of the capital from the investors. The venture capital firm plays are very active role in the management of the companies they are investing in.

What is the catch? Investing in private equity is among the most riskiest of investments. Once you have made the investment, it is very difficult to cash out and in most cases the investor will not get any income. The good news is as long as the investor can accept the high risk and illiquidity of it all the returns can be spectacular.

How can investors get their money back? There are three potential exit strategies for private equity investments:

1.IPO
2. Merger or acquisition
3. Secondary buyout.

The merger or acquisition is the usual one and on this occasion the investor can get their money plus more.

As I said private equity is very risky and you need large amounts of cash but the rewards can be significant. No risk no reward!

The rule of 72

How long will it take for your money to double in an investment? What a great question.With everything going on in the market today your financial adviser would be well within his or her rights to say, "who knows?" Of course that is a short term view and as most of us should know the market will go up over time. In the short term things are always going to be choppy like the waters of Cook Strait however in the long term we should see returns. So, how do we calculate how long our money will take to double?

We use the rule of 72. "What?" I hear you say, "What is the rule of 72?" Well the rule of 72 is a very easy way to figure out how long it will take for an investment to double. So if you give your money to the bank and they are paying an annual interest rate of 6% then it will take 12 years for your investment to double. If they give you 9% then you guessed it the investment will take 8 years to double. Simple, eh?

The rule of 72 can also be used for inflation. In New Zealand for the last 150 years the inflation rate has been annually 2.7%. So if we divided 72 by 2.7% then we get 26.6. So our money historically will halve in value in 26.6 years.

The last question is of course, why 72? Well, I have no idea. I"m sure some mathematician spent many hours trying to come up with that one. Good on him I say.

Allen Stanford

As a cricket supporter I would like to change my tune today and talk about someone who has played a major role in cricket in the last few years. Late 2008 in Antigua, England played the West Indies in a T20 match with the winning side collecting a cool $20 million for their troubles. The losing side went home, that's it they went home with nothing. It is now history that the West Indies won comfortably by 10 wickets and pocketed the $20 million.

Allen Stanford was the man behind this game. He had been living in the West Indies for a number of years and had grown attached the sport that is cricket. He had planned to organize five of these games with $20 million on the line for each game. Unfortunately for cricket fans and especially the England and West Indies teams only one of these games were ever played as the following year Sir Allen Stanford was arrested on suspicion of been the front man in a fraud of massive proportions called a Ponzi scheme.

I'm not here to pass judgment on whether or not Stanford is guilty or not, in fact I'm kind of hoping that he isn't as I enjoyed the first game they played and would like to see it continue, as even though the West Indies won convincingly it was still quite exciting, especially with the amount of money at stake and the fact that some of the young players in the Caribbean side were about to become instant millionaires.

So, what is a Ponzi scheme that Stanford has been accused of? Basically a Ponzi scheme is an "investment" in which investors are paid returns from other investor's money or even from their own money. There is actually no profit earned by the people running the show. Naturally for the scheme to be kept going you need an endless supply of investor's money. This can be done when the investor re-invests his or her money because understandably they are happy with the results.

So how do these schemes get found out? Well they get found out one of three ways:

1. The people behind the scheme disappear.
2. The scheme can collapse when the returns are so good that the people behind it have problems paying the      returns and everything turns to custard.
3. The whole scheme gets exposed by a whistle blower or external market forces.

What is the moral of the story? If it is too good to be true, it probably is or do your own due diligence before making an investment.