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Investment Types

January 7, 2013

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Investment Types

There are many types of investment, each with its own level of risk and return. The more money you can make from an investment, the higher the risk that you might not get all your money back. So it’s good to have a mix of different types of investments to spread your risk. And it’s important to do your homework and get investment advice so you understand the risks before you hand over your money.

Bank savings

Savings accounts with New Zealand’s major banks are one of the most common and least risky ways to store your money for the short term.  Credit unions and building societies also offer savings accounts.

When you deposit money in an account you are lending it to the bank, which pays you some interest in return. The interest you can earn is relatively low, so savings accounts are not the best option if you are looking for long-term growth.

Term deposits

Like savings accounts, term deposits also pay interest. The difference is that you agree to lend your money to the bank for a fixed period of time such as 6 or 12 months in return for a higher rate of interest.

Sometimes you can’t withdraw the money during the term of the investment. In other cases you can, but get paid a lower rate of interest. Term deposits are sometimes called ‘fixed interest’ investments.

Bonds

A bond is like an IOU issued by a government, council, or company. You lend them your money for a number of years, and they promise to pay a certain interest rate – called a coupon. The level of risk involved when investing in bonds depends on the issuer. Unlike term deposits, you can sell your bonds early. However the price you will get can go up and down. Bonds are also sometimes called fixed interest investments.

Shares

When you buy a share, you’re buying a small part of a company. If that company makes money, you may be paid a share of the profit, called a dividend.  Like house prices, share prices are generally expected to go up over time and give you a ‘capital gain’ on your money when you sell. However, prices can fall in value as well.

Property

Returns from investing in property come from rental income and from any increase in the value of property over time – called capital gain. Some people view their own home as an investment because it may grow in value. It doesn’t have the income that letting property to other individuals or businesses brings. You can invest in commercial property directly, or through managed funds.

Managed funds and KiwiSaver

A managed fund is a financial product that buys a number of shares and other investments such as property, term deposits, and cash.  The buying decisions are made by expert managers.

When you buy units in a managed fund you are spreading your savings across a range of shares or other investments within the fund. That means that your money is ‘diversified’.

Alternatives

Alternatives is a broad term often used to describe investments that fall outside the standard asset classes of cash, bonds, shares and property. Alternatives include commodities, currency and derivatives.

Commodities (including gold)

These investments don’t pay interest or dividends, but do increase and decrease in value which can result in a capital gain. The value of commodities often moves in the opposite direction of other asset classes (e.g. when share prices go down, gold often increases in value, and vice versa), so investors sometimes buy them to try to protect their money.

Currency (foreign exchange)

As well as being used to buy goods and services, foreign currency is also used as an investment. Currency investors are looking for higher interest rates overseas, or hoping exchange rates will move in their favour resulting in a capital gain. Investors, including managed funds, may also use currency to protect, or ‘hedge’, other investments that are invested overseas.

Derivatives (including options and futures)

Derivatives are generally only used by more sophisticated investors, such as managed funds. This can be a confusing and complex area of investing. However, derivatives are built on a fairly simple concept –  allowing people to protect themselves, or ‘hedge’, against future price movements. For example a farmer can fix the price today, for the milk they will supply in the future. While at the same time, a supermarket owner can fix the price now for the milk they will receive in the future.

Professional investors still use derivatives for this purpose, but can now also use them to invest more efficiently.

Other alternatives

Other alternatives can include things such as private equity, hedge funds, fine wine, exotic cars and stamps. There are different reasons for buying each one, but, as with all investments, their value can go up or down.

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