Investing is the best way to grow wealth and get our money working for us – but how? There are many kinds of investments out there, each with its own level of risk and return. The higher the potential return, the higher the risk that we might not get all our money back. So it’s good to have a mix of different investment types to spread risk and get the results we want. And it's important to do our homework and get investment advice so we understand the risks before handing over our money.
Savings accounts with New Zealand’s major banks are one of the most common and least risky ways to store money for the short term. Credit unions and building societies also offer savings accounts.
When we deposit money in an account we are actually lending it to the bank, which pays us some interest in return. The interest rate is relatively low, so savings accounts are not the best option for long-term growth.
Like savings accounts, term deposits also pay interest. The difference is that we agree to lend 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 we can’t withdraw the money during the term of the investment. In other cases we can, but we get paid a lower rate of interest. Term deposits are sometimes called ‘fixed interest’ investments.
A bond is like an IOU issued by a government, council, or company. We lend them 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 whoever’s issuing them.
Unlike term deposits, we can sell bonds early. However, the price we will get can go up and down. Bonds are also sometimes called fixed interest investments.
When we buy a share, we’re buying a small part of a company. If that company makes money, we 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 a ‘capital gain’ on our money when we sell. However, prices can fall in value as well.
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; however, it doesn’t bring in the income that letting property to other individuals or businesses does. It is also important to factor in the interest paid on a mortgage when assessing the potential for capital gain. We can invest in commercial property directly, or through managed funds.
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. KiwiSaver is an example of this investment type.
When we buy units in a managed fund we are spreading our savings across a range of shares or other investments within the fund. That means that our money is 'diversified’ and our eggs aren’t all in one basket.
Alternatives is a broad term often used to describe types of investments that fall outside the standard asset classes of cash, bonds, shares and property. Alternatives include commodities, currency and derivatives.
Commodities (including gold)
These types of 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. The Financial Markets Authority has more information about forex trading.
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 alternative investment types 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.
Investing by lending our money on a peer-to-peer lending platform or participating in equity crowdfunding are other ways of investing and earning a return. Consumer has more information about crowdfunding and peer-to-peer lending, as does the Financial Markets Authority (FMA).
Capital notes, perpetual subordinated notes and other hybrid securities have some features of both bonds and shares. They're often issued by well-known banks, but they are generally riskier and may not be suitable for many. Here’s more about capital notes from the FMA.