Welcome to the world of investing.
Let’s start with the difference between saving and investing. Saving is setting money aside for things you need to pay for in the near future, like saving for a flat-screen television or to take your extended family to the seaside for their next holiday. Savings are typically accessible and unlikely to earn interest that beats inflation and tax. If your car breaks down you can withdraw money from your savings instead of going into debt.
Investing should be done for longer periods that enable you to beat inflation and tax and to harness the power of compounding (earning interest on interest). For example, buying a new home in 3-5 years’ time, planning to send your child to university in 15 years’ time or retiring comfortably at the age of 65.
Yes, because you contribute towards a retirement fund you are already an investor!
Ata wants to know…
What is an investor?
An investor can be a person (like you), an organisation (e.g. company or government), a collective (e.g. unit trusts), or a financial service provider. Financial service providers invest money on behalf of other investors, and can include banks, insurance companies and asset management companies.
There are certain places where money can grow. No, it’s not on trees. However, your money has the potential to grow if you “plant” it in the right asset classes.
Your long hair or sassy personality is an asset, but in the world of finance an asset is anything that has economic value – something that you can sell for money, like a car, bicycle or smartphone. Savings in the bank are a good example of an asset.
Asset classes are groups of assets that have similar characteristics. Assets in the same class will pose similar risks and offer similar returns.
There are five main asset classes: debt, cash, equities, property and commodities.
1 DEBT INSTRUMENTS
Risk factor: Low-Medium
It sounds counterintuitive but you can invest in debt. Say what? Individuals, businesses and governments can borrow money that must be repaid over time, with interest. An investor (that’s you or your retirement fund) can provide capital with a lump sum in exchange for payments (with interest) at regular intervals, i.e. monthly or yearly. That sounds risky, I know; however, these debt instruments (also called bonds) are guaranteed or backed by an entity such as a government, a bank or a company.
Ata wants to know…
What is interest?
Interest is like paying “rent” for lending or borrowing money. If your credit card is in the red, you pay interest, so you pay the bank for the privilege of borrowing their money. In the same way you can receive interest from the government, bank or company because it is borrowing your money.
2 CASH
Risk factor: Low
Cash refers to any positive balance or deposit in a South African bank account. This includes savings, fixed-deposit or money-market accounts, as well as acquiring other currencies like US dollars or Euros.
Cash is viewed as a low-risk investment. You’re not going to get rich quickly as cash grows slowly and usually at a steady or fixed interest rate. But there’s also very little chance of losing any money.
Nomnikelo explains….
Ata’s retirement fund invests R500 000 in a money-market account with an interest rate of 7% for 12 months. At the end of the year, the money will be worth R535 000. The fund’s money only grew by R35 000, but it didn’t lose any money.
3 EQUITIES
Risk profile: High
Equities refer to the owning of shares. Companies can issue shares to raise money from investors. If you buy shares in a company, you actually “own” a part of that company. The company uses this money to grow and develop its business. Shares are bought and sold on a stock exchange like the Johannesburg Stock Exchange (JSE).
Nomnikelo explains….
Vodacom’s shares are worth R10 each. An asset manager buys R500 000 worth, so 50 000 shares, for your retirement fund. The company performs well, and the share price rises. After a few months the share price is R12, and your fund’s shares are now worth R600 000, thus your money has grown by R100 000. Compare that with the R35 000 from the cash investment! However, the share price could have dropped to R7, and then your fund could have lost R150 000!
4 PROPERTY
Risk profile: High
This asset class includes physical properties that you buy in order to lease, such as houses, office buildings, malls, industrial parks, etc. When you lease your property, you earn rent from the tenants every month. You can also invest in property without buying a physical brick building, by investing in real-estate investment trusts (REITS). You then own a small percentage of residential, commercial or industrial property.
5 COMMODITIES
Risk profile: High
Commodities are raw materials that are bought and sold on global markets where economic forces (supply and demand) and other global issues (e.g. wars, droughts, natural disasters) determine the price. Commodities can include agricultural products like maize, coffee, cattle, fuels like oil and gas, and metals like platinum, gold and steel.
Nomnikelo explains….
Gold is a metal commodity. Ata’s retirement fund invests R500 000 in gold at R1 000 per gram. After a few months, the South African economy goes into a recession. When this happens, many people tend to put their money in gold as it is seen as a safe investment. The gold price increases to R1 100 and Ata’s retirement fund’s value rises by 10% to R550 000.
ALTERNATIVE ASSETS
Risk profile: High
Financial assets that do not fall under the traditional asset classes are called alternative assets. These include private equity, hedge funds and infrastructure.
Nomnikelo explains….
As you can see, debt instruments and cash grow at a steady predictable rate, but the returns are relatively low. Equities, property and commodities are less predictable but can yield much higher returns. Therefore, it is wise to spread your money over a range of asset classes. Instead of investing R500 000 in one asset class, invest a portion in each asset class. Finance lingo for this process is diversification.
Sources:
Overview of asset classes per Regulation 28
Alternative assets: Commodities
smartaboutmoney.co.za
This article was funded by Fairtree Asset Management.
