Risky investments are often considered speculative ones. A true investment can be described as one that is based on a solid rationale and that has a margin of safety.
The risk attached to a share can therefore be understood as the margin of safety attached to that investment - the higher the margin, the lower the risk and vice versa.
A true margin of safety is usually backed by numbers, a convincing argument and has some allusion to actual experience. That brings me to this week's quiz. You only learn from experience if you are aware of your own temperament and tendencies.
See how you fare this week and add it to your score from last week's quiz. All will be revealed in my next column.
1. It is August 2004. You recently bought Digicore at 80c, despite the fact that it was 60c not so long ago. Two months later, it is up 40 percent. There has been some good news about the company, but the share price has already reflected this ... or has it? You would:
a. Sell it;
b. Hold on for further gains; or
c. Buy more - it will probably go even higher?
2. You would rather have:
a. Invested in a high-tech fund that didn't do much for six months; or
b. Invested in a money market fund, only to see the high-tech fund you were thinking about investing in double in six months?
3. Your block of flats is being converted into loft apartments, and you were thinking of moving elsewhere in any case. You can either buy your flat for R400 000 (so it's definitely not in Cape Town) or sell your option to buy for R100 000. You can probably sell the apartment for R600 000, but it may take six months. The financing costs for six months are about R3 000 a month and you would have to borrow money for transfer fees and a deposit. You would:
a. Take the R100 000; or
b. Buy the loft and sell it on the open market?
4. You inherit your aunt's paid-up house, worth R1 million. It is quite run-down, but in a good area. You can get R4 000 a month if you rent it out as it is, or R6 000 if you fix it up. You will have to borrow money to renovate it. You would:
a. Sell the house;
b. Rent it out as is; or
c. Renovate the house and then rent it out?
5. You work for a small, thriving unlisted media company. Management plans to list in four years and staff are being offered shares. If you buy now, you won't get dividends until listing and you won't be able to sell for years, but the share could go up 10 to 20 times when it is listed. You would invest:
a. Nothing;
b. One month's salary;
c. Three months' salary; or
d. Six months' salary?
6. Your old friend and neighbour, an ace geologist, is part of a group of investors that wants to fund an exploratory oil well. If it is dry, you will get nothing, but you could make 50 to 100 times your investment if you strike oil, and your friend thinks there is a 20 percent chance of this happening. You would invest:
a. Nothing;
b. One month's salary;
c. Three months' salary; or
d. Six months' salary?
7. It is 2008 and, would you believe it, inflation is back. You are sitting with government bonds (and obviously did not heed any advice about diversification). Precious metals, coins, art and property are becoming sought after, because they are expected to keep their value. You would:
a. Hold on to the bonds;
b. Sell them, put half the proceeds in cash and half in hard assets;
c. Sell them, and put all the cash into hard assets; or
d. Sell them, put all the proceeds into hard assets and borrow to buy more?
Allocate points to your answers as follows:
1. a = 1; b = 3; c = 4.
2. a = 1; b = 3.
3. a = 1; b = 2.
4. a = 1; b = 2; c = 3.
5. a = 1; b = 2; c = 4; d = 6.
6. a = 1; b =3; c = 6; d = 9.
7. a = 1; b = 2; c = 3; d = 4.
- With acknowledgements
to J. Ware.