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Guide To Understanding Your Investment Options

Contributor:
Sorted.org.nz
Sorted.org.nz

Understanding the product range

 If you're serious about learning more about investing, this section gives you a more indepth overview. You can find out more about diversification, different returns from different product types, the importance of small differences and determining the real rate of return.

 

Diversification

Good investors don't put all their eggs in one basket. They develop a diversified portfolio of investments. This means they have investments which are spread across the four main asset types - short term deposits, bonds, properties, and shares.

These days, with the opening up of global financial markets to New Zealand and new technology, you can invest relatively small amounts in some of the world's most successful companies. At the same time you can automatically have a spread over hundreds of different investments.

You could make endless combinations to spread your investment risk. But the good news is that the savings and investment industries have made it easier for us, by developing a range of funds which combine asset types and have different levels of risk, to suit all tastes.

There is a huge array of managed funds or investment trusts. They vary, but should all have people with expertise and knowledge who pool your savings with others, and then invest the total pool over a range of products or companies.

No matter what type of saver or investor you are, you can find at least a couple of funds that match your investment profile. Your investment profile includes what you need in terms of duration, liquidity , returns and risk.

In each asset class there are many types of products:

How the four asset classes have different levels of risk and returns:

The chart shows that short term deposits are the least risky, but give the lowest return over time. Whereas shares are the most risky, but in the long term should give you a higher return.

How the right investment mix for you depends on your risk profile and when you would want to cash up your investment:

By mixing the four asset classes as well as mixing by industry, country and other features, you can see how fund managers and investment advisers can produce a huge variety of investment schemes with varying degrees of risk, duration, liquidity and types of return. The trick is to find out which mix suits you.

Example: Government stock

Government stock can be bought and sold on the market. The market value of a parcel of $1,000 Government stock moves up and down with interest rate movements; and the level of movement varies according to the number of years before the stock matures and the Government repays the loan.

For example:

Date Purchased
Price & Face Value
Interest Payable
If current interest rate is 6.5% then:

2003
$1,000
7%
This stock is worth more than $1,000

2006
$1,000
6%
This stock is worth less than $1,000

Scheme names

You'll find investment schemes and funds have a variety of names, eg, unit trusts, managed funds, listed investment trusts, superannuation funds, balanced funds, growth funds, income funds, capital protection funds, etc.

What's important is not the name or description. The important thing for you is to work out if the features of a particular scheme match your needs, and that it is good value for money.

See how you can expect to get different returns from different product types.

 

Determining the real rate of return

The key factor determining the real rate of return is the mix of growth and income assets. This is called 'asset allocation'.

In the long term, growth assets should produce a higher return than income assets, but the returns from growth assets are more volatile and involve greater risk.

The return on income assets is fairly constant from year to year, whereas growth assets may provide a high return one year and a loss the next. But over time growth assets should provide a higher return. The return comes from both income and capital gain.

Taxation, investment management fees and inflation all affect your real rate of return (your return after the cost of these factors has been deducted). So when people tell you about returns, make sure you know if all these factors have been considered and compare the fees and tax position of different products.

Be wary if you're advised that a balanced portfolio can achieve average long term returns well above those in our chart. Some parts of a balanced portfolio may give higher returns but will probably be offset by lower returns in other parts.

  • Remember no-one can guarantee what future returns will be.
  • A higher risk means a greater chance of losing money in any given year, but the possibility of achieving higher returns over the long term.
  • Don't believe anyone who says they can give you high returns every year without very high risk.

Summing up the product range

Obviously, the potential product range is huge, and you may or may not want to devote time to fully understanding it.

If you want to invest, work out your requirements and ask advisers or product providers to find you a few suitable products. Then use the Sorted.org.nz product comparison checklist to help you work out which product best suits you.

If you have access to an employer superannuation scheme, check that out. It's likely to be your best option for long term saving.

Content provided by Sorted.org.nz, Your Independent Money Guide. 

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