Tips & Tricks: Investments Explained

There are many different types of investment.  The four most common asset types or classes are:

1.  Short Term Investments

Bank savings accounts

The simplest kind of short term investment is a savings account,  Returns are lower compared to the potential earnings on other investments.  However, the amount you invest will always be returned to you, it won't drop in value like some other investments can. 

You can withdraw all or part of your money whenever you want (total liquidity).  This makes savings accounts ideal for short term savings goals, or as a place to keep your emergency fund.  They may not be a good investment option for long term goals unless you are not worried about the amounts of extra income you will get.

Bank fixed term investments (term deposits)

Term deposits mean you give the bank a lump sum for a set period (ie. a fixed term) - usually between three months and five years.  Your money is locked away for the fixed term.  In return you get a higher interest rate than you get for savings account balances.  You may be able to withdraw your money early, but your interest will be adjusted to a lower rate.  This is because you have entered into an agreement with the bank to invest your funds for a particular period of time and the bank relies on holding your money.  If you want your money back early the bank needs to find new sources of funds to replace your investment.  Term deposits can be a good short or medium term investment, depending on interest rates.

2.  Bonds

A bond is like an IOU issued by a government or a company.  You give them money for a set period of time and they promise to pay you interest at an agreed rate and time(s) and repay the amount you invested at the end of this period.

Bonds lock your money away for a set period of time, but they can sometimes be traded (bought and sold through an exchange).  Generally, bonds are not a good short term investment.  Small investors do not usually trade in bonds; it is more usual to invest through a managed bond fund.

3.  Property

For most New Zealander's, their home is their largest investment.  Your requirements for a home change over time so it is good to periodically review whether you have too many eggs in one basket.  Think about your retirement, at some stage it may be a good idea to split your investments between your home and another investment.

Rental Property

Returns from property investment come from rental income, less expenses, and from the increase in the value of your property over time (capital gain).  If the value of the property increases between the time you buy and sell it, you will receive back more than you initially invested.

A property management company can take on the tasks of finding tenants, collecting rents and bonds, and attending to any issues etc on your behalf to keep your investment low maintenance.

Rental property is an excellent long term investment, ideally a property should be held for 7 - 10 years to maximise potential return.

4.  Shares

By investing in shares in a company that is listed on the stock exchange, you receive the right to share in the future income and value of that company.  Your return can come to you in two ways:

1.  Dividends paid out of the profits made by the company
2.  Capital gains if you are able to sell your shares for more than you originally paid for them

Any loss or gain in the value of shares is said to be 'realised' when you sell the shares.  If you hold onto them the loss or gain is 'unrealised' until you sell them.  The price of shares in a listed company can vary from day to day, some will go up and some will go down depending on how the investment community view the prospects of each company.  Some companies will fail and some will flourish.

Share prices are volatile (ie. can go up or down quickly) and so it is not wise to invest in shares with funds you may need in the short term.  When you do need your money, you will generally be able to sell you shares but the price at that time may be well below what you paid for them.  Shares should be used as a long term investment, using only money you do not need for other purposes.