The JSE and Making Investment Decisions (Grade 12 NSC Matric Business Studies): Revision Notes
The JSE and Making Investment Decisions
Key concepts and definitions
Understanding investment terminology is essential for making informed financial decisions. Here are the fundamental concepts you need to know:
Investment refers to the process of setting aside money with the goal of generating profit over time. When you invest, you're essentially putting your money to work for you.
Investors are individuals who save money with the expectation of earning a profit from their investment activities. They take calculated risks to grow their wealth.
Risk represents the uncertainty that losses might occur instead of the expected profits from an investment. All investments carry some level of risk.
Interest is the money earned by an investor as a return on their investment. This is essentially the reward for lending or investing your money.
Dividends are payments made by companies to their shareholders, representing a portion of the company's profits distributed to owners.
The Johannesburg Securities Exchange (JSE) serves as the marketplace where shares of listed companies are bought and sold in South Africa.
A share represents partial ownership in a company. When you buy shares, you become a part-owner of that business.
Investment periods can be categorised as:
- Short-term investment: Less than one year
- Long-term investment: More than three years
Understanding these timeframes is crucial for aligning your investment strategy with your financial goals.
Bankruptcy occurs when a business cannot repay its debts to creditors, whilst liquidation involves selling a company's assets to pay off its debts.
Functions of the Johannesburg Securities Exchange
The JSE plays a crucial role in South Africa's financial system and was established during the first South African gold rush in 1887. Today, it ranks as the 16th largest stock exchange globally and the largest of Africa's 22 stock exchanges.
The JSE serves as the backbone of South Africa's financial markets, connecting investors with investment opportunities and facilitating economic growth across the continent.
The JSE serves several important functions in the South African economy:
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Facilitates investment opportunities for financial institutions like insurance companies, allowing them to invest surplus funds in shares
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Acts as an economic barometer by providing insights into South Africa's economic conditions through market performance
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Keeps investors informed by publishing daily share prices, helping investors make informed decisions
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Connects investors and companies by serving as a link between those who need capital and those who have money to invest
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Provides professional valuation of shares through expert assessment and analysis
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Encourages small investor participation by making it possible for ordinary citizens to participate in the country's economic growth through share ownership
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Makes venture capital available through open market operations
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Creates an orderly market that provides discipline and structure for securities trading
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Raises primary capital by encouraging new investments in listed companies
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Mobilises funds from insurance companies and other institutional investors
Factors to consider when making investment decisions
When deciding where to invest your money, several key factors must be carefully evaluated. The primary goal is always to achieve a positive return on your investment, meaning you want to get back more money than you originally invested.
Return on investment
Return on investment represents the additional money you earn beyond your original investment amount. This extra amount is typically expressed as a percentage of your initial investment.
Several important principles govern investment returns:
- Higher-risk investments generally offer the potential for higher returns
- Lower-risk investments typically provide more modest returns
- Your return should ideally exceed the general inflation rate to maintain real purchasing power
Worked Example: Calculating Simple Interest Return
If you invest R5,000 in a fixed deposit at 20% simple interest for five years:
Step 1: Calculate the interest earned Interest = Principal × Rate × Time Interest = R5,000 × 20% × 5 years = R5,000
Step 2: Calculate total value Total value = Principal + Interest = R5,000 + R5,000 = R10,000
Step 3: Calculate return on investment Return on investment = R10,000 - R5,000 = R5,000
Risk
Investment risk refers to the uncertainty about whether you'll experience gains or losses from your investment. Understanding different types of risk is crucial:
Common Risk Misconceptions to Avoid:
- Believing that past performance guarantees future results
- Assuming that all investments within the same category carry identical risk levels
- Ignoring the relationship between risk and return - higher potential returns almost always mean higher risk
- Different investments carry varying risk levels - some investments are naturally riskier than others
- Shares may lose value over extended periods, and some companies may face financial difficulties
- Higher-risk investments typically offer greater potential for substantial returns
- Ordinary shares carry higher risk because if a company faces bankruptcy, shareholders may lose their entire investment
- Preference shares offer lower risk since preference shareholders have priority claims on company assets if liquidation occurs
Investment period
The duration of your investment significantly impacts your decision-making process. Investment periods are classified as follows:
| Investment Period | Time Period |
|---|---|
| Short-Term | Up to 2 years |
| Medium-Term | 2 to 5 years |
| Long-Term | More than 5 years |
Consider these factors when choosing your investment period:
- Short-term investments allow quicker access to your money but may offer lower returns
- Long-term investments typically provide higher returns as they give your money more time to grow
- Personal circumstances should guide your choice - consider when you might need access to your funds
- Investment objectives will influence the appropriate time horizon for your goals
Inflation rate
Inflation represents the general increase in prices of goods and services over time, which reduces the purchasing power of money. This economic factor significantly impacts investment decisions:
Understanding Real vs Nominal Returns:
If inflation is running at 6% per year and your investment returns 8%, your real return is only 2%. This means your purchasing power has increased by just 2%, not the full 8% return you received.
- Higher inflation rates reduce the value of money over time
- Smart investors seek investments where returns exceed the inflation rate
- Certain assets like property tend to increase in value as inflation rises, providing protection against inflation
- Real returns matter more than nominal returns - your investment should grow faster than inflation to maintain purchasing power
Taxation
Tax considerations play an important role in investment planning and can significantly impact your actual returns:
Tax Planning for Investments:
Different investment vehicles have varying tax implications. For example, interest from savings accounts is taxed as income, while capital gains from share sales may be subject to capital gains tax. Understanding these differences helps optimise your after-tax returns.
- Investment returns are subject to taxation by the South African Revenue Service (SARS)
- Different investment types may have varying tax implications
- After-tax returns are what really matter for your wealth building
- Tax planning should be incorporated into your investment strategy to optimise returns
- Professional advice may be beneficial for understanding complex tax implications of different investment options
Liquidity
Liquidity refers to how quickly and easily you can convert an investment back into cash when needed:
- Highly liquid investments can be converted to cash quickly and easily
- Less liquid investments may take more time to convert or may involve penalties
- Emergency funds should be kept in highly liquid investments like savings accounts
- Long-term investments can afford to be less liquid since you don't need immediate access
- Balance is important - maintain some liquid investments while pursuing higher returns in less liquid options
Liquidity Comparison:
High Liquidity: Money in a savings account can be withdrawn immediately at an ATM or bank branch.
Low Liquidity: An investment in property requires finding a buyer, negotiating terms, completing legal processes, and may take several months to convert to cash, plus involves transaction costs like transfer fees and agent commissions.
Key Points to Remember:
- The JSE serves as South Africa's primary stock exchange, facilitating share trading and connecting investors with companies
- Investment decisions should consider six key factors: return, risk, investment period, inflation, taxation, and liquidity
- Higher returns typically come with higher risks- there's no such thing as a risk-free high return
- Your investment timeframe significantly influences which investment options are most suitable
- Always aim for returns that exceed inflation to maintain real purchasing power
- Consider tax implications when evaluating potential investment returns