Investing 101: Need-to-know basics to build your wealth
Whether you’re a late investment bloomer or you’re 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 on your journey, here’s a quick breakdown of the basic concepts and jargon you need to know:
1. What is investing?
Saving involves gathering together or hoarding funds, usually by setting aside a portion of each of your pay checks. 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 had 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.
2. Types of investments
As previously mentioned, there are a variety of different types of investments or asset classes available. These include:
Shares or equities
A share represents a portion of ownership in a company. Companies issue shares to raise money to grow their businesses, which is then bought and sold by investors on stock markets such as the Johannesburg Stock Exchange (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.
A bond is a financial tool that is used by governments, local authorities, SOEs 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 5-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.
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 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 maturation dates of less than a year. However, while cash investments offer 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.
3. 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 23 May 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.