Investing is taking money you have saved and using it to try to make more money for you.
Depending on the sort of investment you make, you may earn income in the form of interest, dividends or rent.
To make the most of your money, and to understand which type of investment suits you, you need to know the basic principles of investing.
Types of investment
There are many different types of investment. The four most common asset types or classes are:
Within each of these asset types there are investments to suit different appetites for risk, timeframes, returns and needs to access your funds. There are also different ways of investing. You can invest directly. Or, you can invest in a managed fund where fund managers pool your money with that of other investors and invest the funds in a range of assets. You choose the type of assets you want to invest in, then the fund manager makes the investment decision for you.
1. SHORT TERM INVESTMENTS
Bank savings accounts
The simplest kind of short term investment is a savings account. Returns are lower compared to the potential earnings on other investments. However, the amount you invest will always be returned to you, it won't drop in value like some other investments.
You can withdraw part or all of your money whenever you want (total liquidity). This makes savings accounts ideal for short term savings goals, or as a place to keep your emergency fund. They may not be a good investment option for long term goals unless you are not worried about the amounts of extra income you will get. Go to savings accounts to check out the ASB savings account options.
Bank fixed term investments (term deposits)
Term deposits mean you give the bank a lump sum for a set period (a fixed term) - usually between three months and five years. Your money is locked away for the fixed term. In return, you get a higher interest rate than you get for savings account balances. You may be able to withdraw your money early, but your interest will be adjusted to a lower rate. This is because you have entered into an agreement with the bank to invest your funds for a particular period of time and the bank relies on holding your money for that time. If you want your money back early the bank needs to find new sources of funds to replace your investment.
Term deposits can be a good short or medium term investment, depending on interest rates. Interest rates are always changing - sometimes they go through a 'high phase' - this is usually a good time to have money on fixed term deposit. Go to savings accounts to check out the ASB savings account options.
2. BONDS
A bond is like an IOU issued by a government or a company. You give them money for a set period of time, and they promise to pay you interest at an agreed rate and time(s) and re-pay the amount you invested at the end of this time.
Bonds lock your money away for a set period of time, but they can sometimes be traded (bought and sold through an exchange). Generally, bonds are not a good short term investment. Small investors often do not invest directly in bonds; it's more usual to invest through a managed fund.
3. PROPERTY
For most New Zealanders, their home is their largest investment. Your requirements for a home change over time so it is good to periodically review whether you have too many eggs in one basket. Think about retirement because at some stage it may be a good idea to split your investments between your home and another investment.
Rental property
Returns from property investment come from rental income, less expenses, and from the increase in the value of your property over time (capital gain). If the value of the property decreases between the time you buy and sell it, you will receive back less than you initially invested.
If you’re interested in direct property investment, you can manage the day-to-day administration of your rental property yourself, or use a property management company to do it for you.
A property management company takes on the tasks of finding tenants, collecting the rent and bond money, and attending to maintenance issues etc on your behalf. The fees charged for these services are usually a percentage of the rental income.
For an indirect property investment, you can invest in a KiwiSaver scheme, private superannuation scheme or managed investment fund that invests some of your money in property. This could be by way of ownership of rented buildings or by way of an investment in shares of public companies, specialising in property ownership.
Indirect property investment is another investment option that gives you the advantages of property ownership without having to find the property and do the hands on management yourself. This type of investment also makes it easier for the average investor to have a variety of investments.
4. SHARES
By investing in shares in a company that is listed on a stock exchange you get the right to share in the future income and value of that company. Your return can come to you in two ways:
- Dividends paid out of the profits made by the company.
- Capital gains if you're able to sell your shares for more than you paid for them.
Gains may reflect the fact that the company has grown or improved its performance or that the investment community see that it has good future prospects.
Of course, shares can also lose value.
Any loss or gain in value is said to be 'realised' when you sell the shares. If you hold onto them the loss or gain is 'unrealised' until you sell them.
The price of shares in a listed company can vary from day to day. Some shares may go up in value and some go down, depending on how investors view the prospects of each company. Some companies will fail and some will flourish.
Overall the long term trend is for the value of listed companies to increase at a rate higher than inflation. Therefore by investing in a wide range of companies operating in different industries and countries, an investor has a good chance of making long term gains. Remember that in assessing the return from shares you need to take into account dividends received as well as capital gains.
Because of the volatility of share prices (ie the fact that in the short term they may go up or down) it’s not wise to invest in shares with funds you may need in the short term. When you do need your money you’ll generally be able to sell your shares, but the price at the time may be well below what you paid for them. Shares should be used as a long term investment, using money you do not need for other purposes.
Methods of investing - direct v managed funds
Direct investmentYou can invest directly in term deposits, bonds, shares and property or you can place your money in a KiwiSaver scheme, private superannuation scheme or managed fund and have full time specialists look after most of the investment decisions for you.
For some people making their own investment decisions and taking a more hands on approach gives them personal satisfaction. It also saves paying management fees. If you’re interested in direct investment talk to an accountant or adviser. You can start with an NZX Market Participant if it’s shares you’re after. Go to ASB Securities to find out about ASB Securities’ services in this area.
Direct investment in shares in specific companies or selected rental properties should only be undertaken if you have detailed knowledge about those assets or you are prepared to pay for specialist advice. Particularly in the case of property investment, you need to be willing to either spend the necessary time on administration and management, or pay a property management company to do this for you.
If you want to invest directly in shares or property remember the importance of investment period (duration), risk you are prepared to take, diversification across a range of investments, the returns you expect and how quickly you could sell if you had to (liquidity).
Managed funds
In a managed fund your money is pooled with that of other investors, and a professional fund manager invests it in a variety of assets. Managed funds come in many forms - different funds invest in different types of assets for different objectives. Managed funds allow investors access to markets which may otherwise be difficult to invest in. For example, you can invest more easily overseas or in commercial property.
Other funds look for solid long term growth from a range of deposits, bonds, and shares - usually a better place for investing a lump sum intended for your retirement. Financial advisers, banks and insurance companies can all advise you on managed funds that match your investment needs.
Talk to an ASB Investment Adviser about managed funds or any other investments.
PIEs (Portfolio Investment Entities) could have tax advantages for some people. Some managed funds target all-out growth and invest more in high risk shares that could rise dramatically or just as easily drop drastically. For this reason, you should only invest that portion of your funds that are not absolutely vital for your future plans.
*With thanks to Sorted.co.nz for information included in this section.
Disclosure Statement is available on request and free of charge.
