Published on 01/06/2023
By Liv Lewis-Long
Investing can be a powerful tool for growing your wealth and securing a better financial future. Yet, fear of the unknown often holds people back. Use of jargon and complex sounding concepts can act as a barrier for many Kiwis to “get ahead” financially. When a few members got in touch recently asking for simple explanations for key financial terms, we wanted to help!
We believe that with a little understanding and knowledge everyone can learn how to invest and unlock the potential for building wealth and achieving their financial goals. Below, we provide a list of common terms which will hopefully help demystify investing and give you the confidence to start building your own financial future.
Let’s start with some high-level concepts:
An investment refers to the allocation of money or resources into what we refer to as assets, which can include shares, bonds, real estate or even just money (cash). Investments are usually designed with the goal of generating income or growth in asset value over time. People or companies tend to make investments in order to grow their wealth or achieve specific financial objectives (for example generating a passive income, retirement planning or funding new pursuits).
An investment fund, also commonly referred to as a managed fund or unit trust, is a pooled investment which many individuals invest money in, to be collectively managed by a professional fund manager. Investment funds often allow you to access a diversified portfolio of assets, such as shares, bonds, property or cash without having to directly select, buy and manage them individually yourself. There are also “single-sector” investment funds which focus on one type of asset, but these types of funds can still provide exposure to multiple assets of that type - for example a fund made up of multiple shares.
Returns are a measure of what someone ‘gets back’ when they invest, i.e. the money they make - from investments going up in value, or income that they generate (e.g. interest, rent, dividends). Returns can be either positive (i.e. making money) or negative (meaning your investment loses money). It’s important to consider the associated risks when balancing projected returns - often investments that have higher projected or actual returns are riskier and can be more volatile.
And now, to dive into a little more into the detail of what and how investments are made up:
Shares, also known as stocks or equities, represent ownership in a company. When you buy a share, you essentially become a part-owner of that company. Investing in shares means purchasing a portion (which can be a very small portion!) of a company's profits and resources. If the company grows and becomes more valuable, the value of your shares can increase, allowing you to earn a profit (sometimes distributed periodically to investors as “dividends”). However, share prices can also go down, meaning that the value of any shares you have purchased would also decrease - essentially generating a negative return. Shares are a type of growth asset because they are often traded on a public market and have more potential to grow in value over the medium to long term than income assets (they also involve more risk and will have greater ups and downs in value over time).
Bonds are like loans issued by a company or the government. When you invest in a particular bond, you are lending your money to the issuer (the company or government) in exchange for pre-defined regular interest payments, over a specified period of time. At the end of the bond's term, the issuer returns the initial amount invested. Within a fund, the interest payments on bonds are usually recycled into other investments. Bonds are a type of income asset because they receive a regular amount of interest. Income assets generally have fewer ups and downs in value than growth assets and involve less risk, but in general will have lower returns over the long term than growth assets.
Fixed income refers to investment assets that provide either a fixed or predictable stream of income over a specified period. It typically includes bonds, term deposits and debt investments offered by companies, governments or other structures. Fixed income investments, as the name suggests, are a type of income asset, and are considered relatively lower risk compared to growth assets and can provide a steady income stream that is often re-invested if they are held by an investment fund.
Asset allocation is the mix of different asset classes (types), such as shares and property (growth assets) and bonds and cash (income assets) within a fund or investor’s portfolio. The asset allocation is made based on the investor or investment fund’s goals, risk tolerance, and time frame. A common goal of asset allocation for an investment fund manager is to create a balanced and diversified fund, often with a mix of growth and income asset classes, that can potentially generate optimal returns for its members, while managing risk within the suggested investment timeframe.
Currency hedging is a strategy used to manage the risk that investments held in foreign currency (i.e international assets) fluctuate in value due to changes in the exchange rate between their currency and the New Zealand dollar. Hedged investments use specific methods to lock an exchange rate between the New Zealand Dollar and the holding currency, for some of the value (partially hedged) or all of the value (fully hedged) of the investment - this reduces or eliminates the impact of exchange rate fluctuations on the investment’s value in New Zealand dollars. Unhedged investments mean that the value of the investments will be impacted by any foreign exchange movements - which can mean the investment goes up or down in value more as a result.
There are of course many other investment terms out there worth understanding - Sorted.org have a comprehensive glossary if you’d like to explore a few more! By taking the time to understand commonly used investment terms and concepts, you'll gain the confidence and knowledge needed to make informed decisions around investing, once you’re ready to dive in. We recommend talking to an independent financial adviser for more personalised advice should you need it.
Giving back is baked into Simplicity’s business model
In the world of finance, the pursuit of…
Investing in homes is the Kiwi way.