10 Investing questions answered in plain English
Thu Sept. 12th 2019
Investing doesn't have to be scary if you have basic knowledge to bolster your confidence. Here we answer basic investing questions without jargon.
Investing seems largely out of reach to many people (and Wall Street has especially shut out women). But it doesn't have to be inaccessible or scary if you have basic knowledge to bolster your confidence.
1. WHAT ARE BLUE-CHIP STOCKS?
Blue-chip stocks are stocks from public companies that have strong reputations, often household names like Microsoft and Exxon. Blue-chip stocks come from companies with demonstrable ongoing success that typically deliver good returns for their shareholders over time. But don't let that fool you into thinking that these companies are infallible or unaffected by the market at large. They, too, can have bad quarters or bad years. But overall, blue-chip stocks are often seen as solid bets.
2. WHAT'S DAY TRADING? IS IT FOR ME?
Day trading is pretty much what it sounds like: buying and then selling stocks (or other financial instruments, like bonds or mutual funds) in the same day. In general, day traders make their money by investing large sums and taking advantage of small fluctuations in stock prices. These investors are also called "speculators," since their primary goal is to turn a quick profit.
Day trading is risky and not for the faint of heart. For a long time, it was primarily something done at big financial firms or by full-time, professional speculators. Today, with the rise of electronic trading, more hobbyists are giving it a go. That said, it's probably not the right place for a beginner investor to get started — and it also comes with big tax implications. Whatever you do while investing, don't be lured by the idea of "beating the market." Studies show that it's essentially impossible.
3. WHAT IS HEDGING?
Sometimes people talk about hedging as a form of "insurance" for an investment (think of the expression "hedge your bets"). A perfect hedge would take 100 percent of the risk out of a portfolio, but in the real world, that's more of an ideal than something that can actually be achieved.
One of the ways that people go about hedging is by buying derivatives, which are investments designed to balance risk. An investor might put some of their investment into derivatives to balance out the risk of their portfolio. If you're concerned about your level of risk, you can bring this up with your financial advisor.
4. SHOULD I PAY OFF MY DEBT BEFORE I INVEST?
The paying off debt vs. investing question comes into play only if you have extra cash on hand. That means you're paying at least the minimum on your debts, covering your other expenses and still have money left over.
If you do have extra money, first consider how much your debt is costing you by finding exactly how much you owe and what the interest rates are. Use a debt repayment calculator to crunch the numbers on how much interest you will pay over time on your debt.
Next, decide if the potential return on your investment outweighs the cost of your debt. For example, investing money in your KiwiSaver that you project to earn a 7 percent return makes investing more attractive than paying off a student loan at 4 percent interest. You still come out ahead if the investment return you're expecting comes to fruition. However, the credit card interest — which is likely much higher — pales in comparison.
5. I HAVE SOME MONEY TO INVEST. WHERE SHOULD I START?
When getting started with investing, it's a good idea to educate yourself on the options available and narrow down your goals. If you work you should strongly consider investing in a KiwiSaver first, and benefiting from employer contributions as well as your own.
Decide on how much to invest, or how much you need to achieve your goal, and when you want to do this by. Then work backwards and break the amount down in to yearly or monthly amounts.
There is a common misconception that you need a lot of money to start investing, but this is simply not true. The longer you wait to build up a sum of money to make a start with, the more you are missing out on the rewards of investing, such as compound interest.
Sit down with a financial adviser and investigate which investment option is right for you. If you already have investments, your advisor can help you decide where to go with them, and what adjustments to make.
For more tips on what to do with available money, check out our blog post 'What to do with a Windfall'.
6. HOW DO I EVALUATE AN INVESTMENT?
The basic goal of an investment is to make money, right? So you want to look for opportunities where the upside (aka potential to make money) is as high as possible, while balancing risk. You always have the option to pick individual company stocks or bonds, but that can be tricky. One common tool to get around that trickiness is a mutual fund or an exchange-traded fund (ETF). They offer portfolios with a bunch of investments that you might not be able to buy on your own given your resources. So, rather than buying one share of Apple stock, you can invest in one share of a fund that invests in a much larger portfolio of large U.S. companies (including Apple). This means you don't have to be a stock-picking genius who can spot the next big thing. You spread your investments around a lot more and temper your risk.
When evaluating a mutual fund or ETF, take a look at a site like Morningstar.com, an independent research tool for investments. Consider the fund's Morningstar Category to get a better idea of what type of investment you are looking at.
Next, look at the fees associated with this investment. The annual fees, also known as an expense ratio, are expressed as a percentage of your total investment. For example, an expense ratio of 0.50 percent means you will pay $5 annually to invest $1,000 in this fund.
7. WHERE CAN I GO FOR INVESTMENT ADVICE
Make sure you can determine whether you're being told or sold! Advice on investments in widely available, so check that the adviser you choose is licensed to provide what you need. A good adviser will help you find the right mix of of investments based on your goals and attitude to risk.
Robo-advisers were revolutionary in changing the choices and costs for investment management, but remember they rely on algorithms. This method requires little human interaction - you simply set parameters of time, risk, and how much you want to invest, and then you let the robo do the rest. A Financial Adviser on the other hand can manage all aspects of your financial life. Advisers also have an obligation to ensure that the recommendations they make are suitable for you.
The FMA has some good tips to consider when choosing an adviser.
8. WHAT IS THE MINIMUM AMOUNT OF TIME I SHOULD PLAN TO LET MY MONEY SIT IN AN INVESTMENT ACCOUNT?
A balanced portfolio held over the long term often outperforms frequent trading, so it's important to let the market take its course and not make knee-jerk decisions.
You also want to consider the tax consequences of selling any investments. Whilst New Zealand is currently not subject to Capital Gains Tax, there are taxation laws around the buying and selling of property in a 5 year period.
9. HOW DO I KNOW IF I'M READY TO INVEST? IS THERE A FINANCIAL THRESHOLD YOU SHOULD AIM FOR?
No, there's no magic number that you need to hit to know you're ready to invest. As long as you can cover your necessary expenses comfortably and have some sort of cushion or rainy-day fund, it's a great idea to put as much into these types of retirement accounts as you possibly can (up to the yearly limits). There's no hard-and-fast rule about how much money you should have before you start to invest, but as long you're meeting your day-to-day needs and have a way of dealing with any major emergencies that may arise, putting your money to work for you is a great idea.
10. SHOULD I INVEST IN INCREMENTS, OR ALL AT ONCE?
A lot of people find that it can be a little uncomfortable to start investing money if they're used to bringing home a certain amount each paycheck. To get started, you might want to dedicate, say, 5 percent of your income to investing. Over time, you can increase that number. A good retirement calculator or retirement planner will give you a sense of how much you need to be investing on a monthly or yearly basis in order to reach your goals. You don't have to go from zero to 20 percent overnight, but the earlier you start to save, the more you'll benefit over the long run.
Credit: Article taken from hermoney.com, by Karen Carr Nov 18, edited for the purpose of use in New Zealand.
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