Eight key investment nuances first-time investors should know
Investment jargon – used by ‘those in the know’ ad nauseum – can be very intimidating, and sometimes even a barrier to entry for first-time investors. Understanding what your financial advisers are talking about, and getting to know their world a little, will help new investors get started with their first investment and, ultimately, make better investment decisions.
“Financial literacy is extremely important, especially because South Africa’s economy is struggling, which will have a direct impact on many people’s pockets. Being financially savvy can help people understand the basic principles of finance, gearing them to navigate this ever-changing financial landscape, manage their risks more effectively, and potentially even avoid financial pitfalls,” says Sheldon Friedericksen, Chief Financial Officer of South African financial services company Fedgroup.
The financial services industry is, unfortunately, filled with acronyms and terms which can become overwhelming. But, Friedericksen believes that that if you know a few of the basic terms, you are already halfway to becoming financially fit.
Here are eight key investment nuances first-time investors should know.
1. Alpha vs beta
The terms ‘Alpha’ and ‘Beta’ are used to measure the performance of stock, a fund or investment portfolio. Alpha measures how an investment has performed in comparison to the market index or benchmark, while Beta measures how variable the investment returns were in comparison to the market as a whole.
2. Actively vs passively managed funds
To outperform the market, actively managed funds require a team of professionals or fund managers to track the performance of an investment portfolio. They regularly make buy, hold or sell decisions based on investment analysis on specific stocks and industries, research and forecasts to ensure that the returns exceed the performance of the overall markets.
Passive management (sometimes called ‘indexing’) is the opposite of actively managed funds, and refers to a buy-and-hold strategy designed to mirror the returns of the overall market, ignoring day-to-day fluctuations of the market.
3. Appreciation vs depreciation
‘Appreciation’ is used to describe assets that are expected to be worth more in the future. These include stocks, bonds, currencies, or real estate. Assets that gradually decline in value, such as cars or computers, are said to ‘depreciate’ (go down) in value over time.
4. Bonds vs stocks
In a nutshell, bonds are debt while stocks are shares in a company. Bonds are considered a safer investment while stocks (also known as equities or shares) are riskier because should the company fail, equity investors are the last to receive payments.
The value of your stocks is also affected by how the company you have bought a share in is performing, and is influenced by various factors. These include the profit of the company as well as how it is perceived to be performing.
5. Diversification
‘Diversification’ is when you diversify your investment across different asset classes (i.e. different types of assets), such as equities, bonds and properties. This spreads your risk, as potential losses in one asset class may be offset by potential gains in another.
6. Balanced fund vs independent stock and bond funds
A balanced fund is a diversified fund made up of a mixture of different asset classes such as stocks, property, bonds, cash and other securities. By investing in different asset classes, the risk is reduced while still providing capital appreciation.
Investing in either independent stock or bond funds, exposes you to both price and interest rate fluctuations. Bond funds have the potential to deliver a modest income while stock funds are volatile but can generate the highest profits.
Before investing in a balanced fund, stock or bond funds it is important to establish your appetite for risk as well as determine your investment objective.
7. Dividends vs returns
Dividends are cash payments made to stakeholders, based on the cost of investment, current market or face value. Returns, on the other hand, are what you earn on an investment over a certain period and accounts for interest, dividends and an increase in the share price. It can be positive or negative.
8. Money market vs capital market
The money market is a short-term lending system that allows borrowers to access the cash they need and lenders to earn more money. The capital market is geared for long-term investing. Companies issue bonds and stocks to raise capital to grow their business, and investors get to share in that growth. In comparison, the money market carries less risk while the capital market can be more rewarding.
In conclusion, Friedericksen says that planning for your financial future is the most important thing you can do today. “By having investment goals and strategies in place, you can ensure that you are financially taken care of in the future or in times of need.”