Following is the third in a four-part series of articles that Dave Voris of Horizon Bank is writing to provide insights on making wise investment decision in this low interest rate environment.
This third article focuses upon the Risk, or Safety, and the Reward relationships of various investment instruments. To discuss Safety, let’s consider two balance sheets: the balance sheet of the Investor; a.k.a. a Not-for-Profit organization, and the balance sheet of the Borrower; a.k.a. the obligor of the debt instrument.
I use these two, side-by-side examples to highlight the investor’s need to understand any default risk potential from the ultimate borrower, or called Safety of the investment within the context of this discussion. As one considers the risk-reward relationship, remember there is no free lunch. Thus, higher rates of return correlate with higher degrees of risk. This is not necessarily bad as long as the board-approved investment policy defines that higher risk as acceptable. If the debt obligor would default and not repay the funds to the Investors; i.e., the Not-for-Profit organizations which are holding investments, could face a loss of principal.
Since few Not-for-Profit finance staff, CEO’s or Board treasurers have the required time to clearly and intimately study the risk of default, they typically either: a) default to some widely discussed, safe, best practices, such as adhering to the $250,000 limit on deposits in any one bank or investing in U. S. Treasury obligations defined as the risk free investment, or b) follow the suggestions of an implicitly trusted advisor to help guide them through the balance of safety vs. rate of return.
Read the two previous posts at:
•Article 1: Summary of Practices from the 2013 AFP Liquidity Study
•Article 2: The Importance of an Investment Policy
Questions? Contact Dave Voris at 317-608-2085 or another Horizon Bank - Indianapolis advisor at (317) 608-2128 or 117 East Washington Street.