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Investing 101: The need-to-know basics

A breakdown of the fundamental concepts, options and jargon.
It’s never too early or too late to start learning about the world of investing. Image: Shutterstock

Whether you’re a late investment bloomer or hoping to join the working world and begin building your financial dynasty in 2020, it’s never too early – or too late – to start learning about the world of investing and how to achieve your financial goals.

To get you started, here’s a quick breakdown of the basics.

What is investing?

Saving involves gathering together or hoarding funds, usually by setting aside a portion of your salary each month. By contrast, investing means buying financial assets such as shares, bonds, property or cash instruments in order to earn a profit and grow your wealth.

If you were to buy a house, for instance, you would hope that the value of the house would gradually increase over time, so that you could one day potentially sell it at a profit.

Likewise, if you buy shares in a company on the Johannesburg Stock Exchange (JSE), you hope that the value of the company – and therefore your shares – will increase over time, until they are worth more than you originally paid. This increase in value is called a capital gain. And while you wait for the right time to sell your shares, the company may further reward you for being an investor by paying you dividends, or shares of its profits.

Investing is key to creating wealth and reaching your financial goals, such as ensuring that you have enough money to live off when you retire.

Types of investments

Various types of investments or asset classes are available, including:

  • Shares or equities

A share represents a portion of ownership in a company. Companies issue shares to raise money to grow their business. The shares are then bought and sold by investors on stock markets such as the JSE. When an investor buys a share in a company, they are purchasing a portion of the company’s profits (or losses), which is why these investors are referred to as shareholders. The terms shares and equity are used interchangeably. They are also known as stocks.

So if you were to buy a share, stock or equity in Mr Price, this would all mean the same thing – that you own part of the company. If Mr Price then (hopefully) grew its business, it would pay you dividends each year, and eventually you might be able to sell your shares at a profit.  

  • Bonds

A bond is a financial tool that is used by governments, local authorities, state-owned enterprises and companies to borrow money from investors. When an investor buys a bond, they essentially provide a loan to the bond issuer (the government or entity that created the bond). As compensation, investors usually then receive regular interest payments from the bond issuers in return. These interest payments cease on the bond’s maturation or ‘expiry’ date, on which day bond issuers promise to repay investors the original amount loaned.

For instance, if you invested R1 000 in a five-year RSA Fixed Rate Retail Savings Bond with an 8.5% yield, you would receive R85 (8.5% x R1 000) in interest each year for five years. At the maturity date, you would also be repaid the original R1 000 investment amount.

  • Property

There are many ways to invest in property, beginning with buying your own home or investing in a buy-to-let property and becoming a landlord.

However, you don’t have to invest in a bricks-and-mortar house to invest in property.

Other options worth considering include investing in listed property, either through a real estate investment trust (Reit) or a property exchange-traded fund (ETF), which are both accessible via stock exchanges.

A Reit is a company that owns and often manages income-producing real estate, while a property ETF tracks the performance of various listed property companies.

  • Cash

Cash investments can refer to investing money in high-interest or fixed-deposit bank accounts, or investing in a money market fund which may hold Treasury bills, commercial papers, short-term certificates of deposit (CDs) and short-term bonds with a maturation dates of less than a year. However, while a cash investment offers greater capital protection and lower risk, it also offers lower returns than other asset classes, and is generally not suitable as a long-term investment if you want to defeat the value-eroding impact of inflation.

What are the risks?

While investing can earn you money, it also carries risks. The greatest risk is that you will lose your money, because unlike bank savings accounts where your capital or money is guaranteed, investments do not carry guarantees. 

Take the example of Steinhoff – on May 23, 2017, Steinhoff shares were worth R50.25 each, but by 11 May 2018, just a few months after its collapse, these shares were worth only R1.60 each.

That said, some investments are far less risky than others, and the amount of risk you are willing to accept will impact your potential returns. An investor who takes on more risk is may earn greater rewards over the long term than an investor who opts for less risky investments.

Practically speaking, no-one would take a risk without the possibility of a big pay-off.  

Your investment time horizon

Time and risk go hand in hand, because the longer the period an individual has to invest, the more risk they are generally willing – and able – to take.

Consequently, one of the biggest factors influencing where you should invest your money is your time horizon, whether this be one year, five years, 10 or even 20 years.

For instance, a short-term investor who only has a year or two before they will need to access their funds will generally prefer less exposure to risk, and rather emphasise safeguarding their funds.

They might then choose to invest their money in a cash-based investment such as a money market fund, or a high-interest savings account. These types of investments carry very low risk, but also offer very limited returns.

By contrast, a long-term investor might consider investing in shares in the stock market.

Historically, shares have generally delivered far greater returns over time than cash investments.

However, the value of shares tends to be far more volatile in the short-term, experiencing moves both up and down. This is why stock markets are generally more suited to investors with an investment horizon of at least five years, if not longer, to successfully ride out different market cycles and see positive returns.

For example, in the 12 months to the end of December 2018, the average SA Equity General portfolio (which hold at least 80% of their investments in shares or equity) delivered negative returns of -8.8%. By comparison, the average SA Money Market portfolio achieved positive returns of 7.3% in the same period.

Over the 10 years to the end of 2018, however, the average SA Equity General portfolio achieved handsome returns of 10.5%, where SA Money Market portfolios delivered returns of just 6.6% – barely above the rate of inflation at 5.4%.

Sector performance comparison

(periods all ending December 31, 2018)

 

1 year

5 years

10 years 

20 years

SA Equity General

-8.8%

3.9%

10.5%

14.7%

SA Money Market

7.3%

7.0%

6.6%

8.4%

Inflation

5.2%

5.4%

5.4%

5.5%

Source: Association for Savings and Investment South Africa (Asisa)

So, while past results are no guarantee of future returns, by matching your time horizon and goals with your investments, you will be able to maximise your chances of success.

Reducing your risk

Investors can reduce their overall investment risk through diversification, or by spreading their risk across different types of investments.

This means investing across the different asset classes (shares, property, bonds and cash), as certain asset classes may perform better than others under different market conditions. For example, during periods of heightened volatility, share portfolios may suffer some losses, while other investments such as property and cash deliver good results.

You can also diversify your investment portfolio by investing in different geographical regions, sectors and industries. 

By not placing all your eggs in one basket, you will be able to reduce your potential for investment losses, and smooth out your overall returns.

Ultimately, there are hundreds of different financial products available to investors looking to put their money to work and build their wealth, all with different characteristics and tax implications.

So if you’re at all uncertain on how to get started or which investments are best suited to your individual financial goals (and wallet), get in touch with a professional financial advisor to discuss your needs.

Tlotliso Phakisi is an investment analyst at Cannon Asset Managers.

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COMMENTS   5

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GET OUT OF DEBT 1ST !!!!!!!!!! DO NOT GET CAUGHT PAYING HUGE INTEREST ON YOUR DEBT WHILST TRYING TO OFFSET IT WITH PALTRY RETURNS. Your debt interest probably surpasses your earned interest. That means you are going backwards. Dr. Debt

Chill Boet. None of us here is into unmanageable debt. Just the normal house debt for the young amongst us. Maybe a car or two as well. And perhaps a motorbike as well. Also a boat perhaps.

And afew clothing accounts, couple credit cards that financed my family’s overseas holiday plus Xmas presents.. And acouple small payday loans to help with paying the last 2 months home loan bond… And the Woolworths food credit card….. Nothing serious bro….
Just chill bro.
Hold my beer, watch this…

Easy to say but think on this. What if SA is junked and the ZAR loses 20% in a month? Better to have borrowed and bought USD or Euros?

Divert part of your investments into global equities and gold coins (KR’s) to guard against rand devaluation.

End of comments.

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