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Investment 101

Wealth Works Managing Director and Authorised Financial Adviser Amy Wilkes talks Investment 101 and why you should never put all your eggs in one basket!

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Wow! The end of the financial year is nearing and we're almost quarter of the way through 2016. In this blog edition I wanted to talk to you a little about investing in shares, bonds, property trusts and building a diversified investment portfolio.

Diversification

If you have a slight shudder when I mention "investing in the share market", don't worry, you're not alone! In fact, the biggest misconception with investment portfolios is there's a risk of losing all your money like investors in finance companies did in recent years.


However, with sufficient diversification, this shouldn't be a risk. In little ole' New Zealand it seems that everyone knows someone that knows someone who lost a bundle of money through collapsed finance companies when the GFC hit. People had seen offers such as "10.39% guaranteed fixed return for 24 months" and thought - what a great investment! We then saw people investing their life savings into these finance companies offering these outstanding "guaranteed" and/or "secured" returns. 

There were two key problems with this scenario:

1. Because the investments were perceived to be guaranteed and safe people invested all their money into the one investment.  Lesson: Don't put all your eggs in the one basket!

2. Lack of knowledge and education in the marketplace - hence the purpose of this blog.  Lesson: If it seems too good to be true... it possibly is!

 

Compounding interest

I believe that if there was a little more knowledge around investing in the share market and building a diversified portfolio, people would feel more confident investing in these asset classes. The power of compounding returns is the key to the success of an investment portfolio. 


For example, if you invested $100 per week from age 25 and earned an average 8%; you'd have over $1.5 million at age 65. Not 25 anymore? Just save a little more! A well designed investment portfolio should have a mixture of cash, fixed interest, listed property and shares. The percentage invested in each of these areas will depend mostly on your time-frame, your tolerance to risk and your expected returns. 


Asset classes

Below I've outlined a summary of each asset class. It's pretty basic "Investment 101", however there are many people that have heard of these asset classes but don't really understand the fundamentals. And why should they? We don't get taught these things at school. Perhaps we should! But don't get me started on that... that's another story altogether.


Cash

A cash reserve within your investment portfolio provides liquidity (easy to return to you quickly). Usually a minimum of 2% would be held in cash to cover management fees and would receive interest or dividends from your other investments. It provides a minimal return, but is considered safe - a bit like your personal cheque account you use for your day to day transactions.


Property

Unlike direct residential property that Kiwis have come to know and love, property within a diversified investment portfolio would be invested in listed property trusts. These trusts own a range of different commercial properties mostly and you would own a share in the trusts. Unlike direct residential property your investment can be liquidated (or cashed up) very quickly. The downside is that you don't get the same leverage that you do in direct property through lending.


Fixed Interest (bonds)

Bonds are generally lower risk than shares as they are effectively a loan that you provide to a business or government wishing to raise capital. 


Here's an example... let's say that Air NZ wanted to buy another ten planes. They would need money or capital to buy the new planes. If they didn't have the cash sitting in the bank they could either go to the bank to ask for a loan or they could issue bonds to the public, which we could then invest in. The bonds issued could offer something like "$10,000 investment will provide 8% return every year for ten years and at the end of the ten years you receive your $10,000 back". 


Effectively you would be giving a loan to Air NZ and Air NZ would have a debt obligation to you. Bondholders and any loans to banks receive payment of their money before shareholders , which is why fixed interest is considered lower risk than shares.


Shares (equities)

Using the above example, let's pretend that Air NZ didn't want to be paying out interest on the loan. Perhaps there were going to be enough new costs with their ten new planes that they didn't want to be paying interest on the loan to the bank or bondholders. In this case, instead of offering bonds they could offer shares. If you purchase shares in a business you are effectively buying a share of that business. The business would pay its rent, staff, debt obligations (to banks or bondholders) etc, and the profits are then shared among the shareholders. Shareholders get paid last, which is where the higher risk comes in. However, there is also greater potential for return. Diversification really is the key. A good mix of cash, property, fixed interest and shares is crucial.


You also need to diversify across different industries i.e; you wouldn't want to invest everything in the hospitality/entertainment industries because if there is a change in the economic environment it is likely they would all be affected in the same way. Ideally you would have include a mix of health, transport, commodities etc.


If you are interested in learning more please make sure you seek good advice. Ensure that anyone you seek advice from is an Authorised Financial Adviser. If you'd like to talk about setting up your own portfolio come and see us at Wealth Works for a complimentary appointment to discuss your options.  


Get in touch today to book your free initial consultation

 

 
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