Key Investment Terms - What You Need To Know
Back to Basics
One of our ambitions is to help international professionals better understand how the financial world works so they can make informed decisions and ultimately be in a better position to achieve their goals. In this back to basics article, the focus is on explaining key financial and investment terms, breaking down the jargon to everyday language.
We will set out key financial and investment terms and explain what they mean, and how they work. If you wanted to know but didn’t know where to look or didn’t want to ask, read on. If you would like more detailed information or to understand how to apply these items to your life, you can contact us directly.
Investing
When you invest you buy into different types of investments. The different types of investments are often called asset classes. An asset class is a group of investments with similar attributes, which are differentiated from other types of investments. Here are examples of some of the main asset classes:
Shares/Stocks/Equity. Shares are sometimes called stocks or referred to as equities. They are three different words for the same thing. A share means you own a proportion, quite literally a share, of a company. A company can be publicly listed which means its shares are listed and traded on a stock exchange, or privately owned, such as if you have your own small business. In investments when you hold shares, it is typically shares in publicly listed companies. They can go up or down in value, and when they go up, so your investment grows. Some shares may also pay a dividend, which is a form of income to the shareholders and reflects distributing or sharing some profit.
Bonds/ Fixed interest. Again there are two terms for the same thing. Bonds are an investment where instead of buying and owning a proportion of an entity, you are lending that entity money. It could be a company, which are called Corporate Bonds, or more likely it is to a government, which are called Government Bonds. Bonds are generally considered safer than shares. If a company goes into liquidation and you own shares, your shares can become worthless and you could lose your money invested. If a bond defaults- they don’t make the loan payments- because you are a lender, you have recourse to get that money back. Large government and large corporate bonds are considered low risk as they are not expected to default on repayments to their lender investors. Larger safe bonds will offer a lower interest rate than smaller and those bonds considered riskier. Bonds can get quite complex but we will leave the details for another article.
Property. Real estate is an asset that many people are familiar with however when it comes to investing, property does not only mean residential housing. It more often refers to other types of property. This can include commercial property – shopping centres, offices, factories, warehouses, storage facilities, wharves, ports, public facilities like schools, hospitals, and aged care facilities, and land. The many different types of real estate have varying risk profiles, opportunities for income and growth, and, as if often the case with real estate, different liquidity profiles. That last point sounds like jargon. A liquidity profile means how easy it is to get some or all of your money out. Selling some types of property can be harder and slower than selling shares.
Cash. Cash takes different forms and serves an important function in a financial plan. Cash comprises money in your transactional bank account for day to day living, term deposits, where you are guaranteed an interest rate if you lock your funds away for a defined period of time, and what is called money market investments. Cash invested in banks in the EU is protected by the Deposit Guarantee Scheme and is very low risk. It provides peace of mind to allow you to cover your living and emergency needs with a very low risk of loss.
Commodities. This is a very broad group that can sometimes be a part of a portfolio. There are hard and soft commodities which are surprisingly self-explanatory: metals are hard and coffee and wheat are soft! Commodities include gold, silver, oil, copper and other metals, traded goods such as milk, eggs, wheat, rice, wool, cooking oil, cocoa, corn, and even cheese. It is not hard to understand that there would be complex markets for trading these items between manufacturers, distributors, and users, however there is also an investment market that trades directly or indirectly on the price of these assets. They are sometimes in a portfolio if it is felt their price might move differently from shares or bonds. That is to say it might provide protection or diversification. Of course there are also speculators.
Alternatives. This is a term that the most confusing so far. It can mean a number of things and is often used to lump all other investments that don’t fit into the above categories together. The more common are hedges and derivatives. A hedge could be an investment structure that is opportunistically trying to exploit an inefficiency in a market, or it could be a conservative/defensive position to reduce risk of short term loss. Derivatives are sometimes used in hedge structures and sometimes used outright. They are sophisticated and complex structures best left to professional investors where there is the potential in some formats to lose more than you have invested. One type of derivative are Options. These give an investor the right, but not the obligation to buy or sell an asset in the future at a price set today.
There are other asset classes that are more specialised and newer structures such as cryptocurrency which is still finding its place.
You now know your corporate bonds from your shares. The next point to clarify is how you access these asset classes. This presents more financial terminology which we will explain here. These are types of investments.
Direct. This means you build your investment portfolio by buying the assets. you would for example buy certain shares, and invest directly in government or corporate bonds. Real estate becomes more difficult due to its large size and price but when you buy your primary residence this is a direct purchase.
More commonly investments are held in the following structures:
Managed funds/ mutual funds. You can hold these in your investment account or depending on the structure, in your pension. When you invest in a managed fund, you are buying a unit (a bit like a share) in a fund. Different funds have different profiles. The manager of the fund will then make decisions to buy particular assets in the various asset classes above. The advantage is that for a small investment amount you can achieve broad diversification which you could not achieve directly. You pay a fee for the fund manager’s expertise to select investments and to manage the fund. The change in the unit price reflects your return on investment.
ETFs (Exchange Traded Funds). This newer type of investment emerged in the last 20 years and is a cross between a share and a managed fund. It is listed on a stock exchange like a share, but it is a managed portfolio like a managed fund. When you invest in an ETF you are buying shares of that investment. Like a managed fund the ETF manager will make decisions about where to invest and what assets to hold. They are often but not always cheaper than managed funds and tend to be thematic. For example they may be an ETF that invests in technology companies in Asia, or one that follows the index of a stock market. An investor will need to research and compare ETFs and funds and usually decide on the right combination to meet their needs.
Discretionary portfolios. This format combines aspects of the above. It relies on a professional investment manager building a portfolio of optimal assets that could be a combination of ETF, managed funds, and direct assets and then actively manages this. They are usually but not always cheaper than a managed fund and provide greater diversification and targeting than just investing in one fund or ETF. The other difference is transparency. When you invest in an ETF or a fund, you may see the top 10 investments in a portfolio, however in a discretionary portfolio you hold the underlying assets directly and you can see clearly where and how your money is invested.
In our next article we will discuss how an investor can access these investment structures and key questions to ask when making the important decisions around how to manage your hard earned money.
We always recommend speaking with a professional and you can contact us at Arisaig Wealth Management for an initial discussion to make sure you are on the right track.
