Commerce / Jul 2017

Thought: Part 1 - Investing 101

Do you know your bull from your bear? Your IPO from ETF? Volatility versus liquidity? Going long or averaging down?  When to buy and when to sell? How about whether to invest, with whom, when and where, how much and for how long?

The Business of Investment is all about the unknown.  In this beginner’s guide, we cut through the jargon and unpack the key principles behind investment.  Come with us as we reclaim the territory from the pinot-swilling hedge fund managers

Australia’s Financial Literacy:

Financial literacy is a combination of financial knowledge, skills, attitudes, and behaviours necessary to make sound financial decisions, based on personal circumstances, to improve financial wellbeing.

In June 2017, the annual Australian Securities and Investments Commission’s (ASIC) Australian Financial Attitudes and Behaviour Tracker showed that only 33% of respondents demonstrated an understanding of the concept of the risk/return trade-off, and only two in five respondents had heard of and understood the concept of diversification

Males (42%) were more likely to understand the risk/return trade-off concept than females (23%), while those 35 years and over (37%) were more likely to have an understanding than those under 35 (23%).

Reflecting our hesitance to seek professional financial advice, only 20% of those surveyed had approached a financial professional.

Money, of the lack thereof, is the single biggest cause of stress in our modern life).  In Rich Dad, Poor Dad (1997), the number 1 personal finance book of all time, Robert Kiyosaki observed how growing up in a house that didn’t regularly talk about and demonstrate good financial management poorly prepared him for adult financial responsibilities.  He got educated and made a multimillion-dollar business out of it.

ASIC is Australia’s corporate regulator but is also the lead Australian government agency working to bolster financial literacy and help investors and consumers make informed financial decisions. In direct response to its 2016 findings, ASIC has added a new online investment decision-making tool to its MoneySmart website to give clear guidance on the key investing concepts of ‘diversification’ and ‘the risk/return trade-off’. This MoneySmart website is a central hub for trusted and impartial financial guidance and tools and is a great place to start when looking to boost financial literacy, through personal research or partner-run courses.

Demystifying Investment

Once a tool for the rich, the stock market has now turned into the vehicle of choice for growing wealth for many segments of the population. Advances in trading technology and low-cost brokerage services on the internet have opened up stock markets so that today nearly anybody can own stocks with the click of a mouse.  Even if you don’t have a portfolio of your own and invest, your own superannuation fund is an investment account so it’s wise to be informed.

Despite, or perhaps because of, the plethora of investment information available online, it is hard for a novice to get a succinct overview of the investment landscape.  We’ve taken matters into our own hands and have created a beginner’s guide to Investment, with thanks to Investopaedia.

Let’s start from the top and work our way down.  Investment can occur with publically listed companies, within an Exchange, or with private companies, outside the regulations of an exchange:

  • Publically-listed, these companies are traded on an “Exchange”, which is a regulated marketplace in which companies, governments, and other groups can sell securities, commodities, derivatives and other financial instruments to the investing public. The first sale of stock by a private company to the public is referred to as an initial public offering (IPO). Equity refers to shares in a publically listed company;
    • Physical Exchange: This is the Hollywood image of the trading floor, with lots of shouting and big screens flashing numbers. The most prominent exchanges are the New York Stock Exchange(NYSE), the Nasdaq, the London Stock Exchange (LSE) and the Tokyo Stock Exchange (TSE);
    • Online Exchange: Trading is increasingly being conducted on electronic exchanges as markets become more sophisticated. As of 2016, the floor of the NYSE processes less than 15% of the overall volume of stocks traded in the United States. Transactions are now spread across multiple exchanges.
  • Privately-owned, the majority of companies are privately owned because public ownership is generally impractical for small and medium-sized business.  Private companies typically rely on their own funds or on venture capitalists for investment, however external investors like VCs reduces the owner’s share of equity and can also reduces the owner’s level of operational control and decision making.

The most common way to classify an investment model is by Asset Class. There are 3 traditional classes and an alternative category, under which many of today’s emerging start-up and venture capital investments sit. It is commonly accepted that owning investments from different asset classes (diversification), can reduce a portfolio’s overall risk or volatility.

 

  • Stocks/shares: as mentioned above, these are typically shares in a publicly listed company and traded on an exchange, which is essentially a marketplace, in which securities, commodities, derivatives and other financial instruments are traded. Stocks can be further divided by their investment vehicle or fund structure (which are essentially pools of money which are professionally managed):
    • Individual shares, equity in a single company;
    • Mutual funds, operated by a money manager the fund includes a selection of companies (typically 20-50) and is structured and maintained to match the investment objectives stated in the prospectus (e.g., conservative, higher risk/return);
    • Indexed funds, essentially a mutual fund but they own a cross section of an entire exchange and in the same proportions as they exist in the market; they are passively managed so much lower fees;
    • Exchange Traded Funds (ETFs): very similar to index funds in that they’re meant to track an index or a measure of a specific market; significant difference is that they are priced throughout the day, and can be bought or sold whenever the markets are open;
    • Hedge Fund: like mutual funds but on steroids – often borrow money to boost earnings, need to be a sophisticated investor – cashed up; not regulated like other markets; riskier but higher returns)
    • Bonds: a debt investment which you loan money to an entity and they pay you back interest and the full amount when the loan/bond “matures”;
    • Cash equivalents: these are “as good as cash” which typically means they’re “Liquid” or able to be turned into cash very quickly – unlike property and equity in a business that isn’t listed on the stock exchange;
      • Alternatives: any non-traditional asset with potential economic value that would not be found in a standard investment portfolio:
        • Real estate: buying and selling property, and Real Estate Investment trusts (REITs),
        • Commodities: resources that affects economy like oil, coffee, bought with futures contracts and traded on exchanges, like shares;
        • Precious objects: gold, silver, artwork etc; and
        • Venture capital: money invested in an early stage business – startup or scaleup;
          • Crowdfunding: investment limited to 10k per business and $100k per individual;
          • Sophisticated investor: must have assets of over $2.5million or annual income of over $250k. It is presumed that they understand the risk associated with the investments and, as such, can make informed decisions, unlike the general ‘retail investor’ who needs further advice.
          • Angel investor: also called informal investors, angel funders, private investors, seed investors or business angels, these are affluent individuals who inject capital for startups in exchange for ownership equity or convertible debt;
          • Venture funds: these are funds that manage the money of investors who seek private equity stakes in startupand small- to medium-sized enterprises with strong growth potential.

Hopefully, this overview has provided some insights and good ideas as you invest for your future. Join us on 25th July as we feature 3 investment experts in our Insight: The Business of Investment talk series.

And jump to Part 2 here for financial advice from the world’s richest and smartest investors.

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