An introduction to understanding assets and the importance of diversification to reduce your investing risk.
Understanding assets and diversification.
The idea of investing can seem daunting; it feels like there's a lot to learn. But you don't need to know a lot to get started. Investments can be as 'everyday' as a KiwiSaver account. Whenever you put your money into buying something that's designed to make more money for you – an asset – that's investing.
What are assets?
An asset, in an investment sense, is something that is designed to make money – whether that's by producing an income or by becoming more valuable itself. Of course, an asset may lose money and drop in value, too.
There are a wide range of assets to invest in, including shares, property, bonds, commodities and currency.
Experienced investors might invest directly, choosing and buying their own investments using their own research. An example of direct investing would be buying a rental property or buying a share of a company using a share trading platform.
Investors can also invest indirectly, putting money into a fund which is managed by someone else. KiwiSaver funds are an example of an indirect investment - your money is pooled with other New Zealanders' money - and it's all invested by the fund managers into a range of different types of assets.
How do assets make money?
An asset can make money in two ways: income and growth.
When you buy a share, you are buying a tiny fraction of ownership in a company. That company makes money itself, and some of that income may be paid out to the shareholders. As a shareholder, you get your proportion of that income, which is paid as dividends. Also, the value of the company may grow over time, which increases the value of your shares. The value of the company can also drop, and dividends can be reduced or stopped.
Similarly, if you buy an investment property, it makes income from rent, or its value can grow over time. The value of your property may go up or down, and the rent can increase, or you may need to lower it to secure a tenant.
Growth assets vs income assets
Assets are (broadly) either growth or income assets.
Income assets provide a regular income, but don't go up much in value. For instance, government bonds and term deposits.
Growth assets don't provide such a reliable income stream, but they are expected to grow in value. For example, shares and property.
Ideally, your investing should include a mix of different asset types. How a fund balances income and growth assets is one factor that determines whether its approach is conservative, aggressive, or somewhere in between.
What is diversification and why is it important?
You can have all your invested money in one asset - for instance, a single rental property. Or maybe, you can have your invested money spread across many different types of assets - some in a managed fund, some in KiwiSaver and some in term deposits.
Diversification is a way of describing how diverse your investments are. A single rental is not a well-diversified investment portfolio. The more types of assets you invest in, the more diversified your investment portfolio is.
Assets can make money, and they can lose money. Having all your money in a single asset leaves you at risk of something going wrong with that asset. By diversifying, you reduce your risk of losses.
Risk and return go hand in hand
In general, the riskier an investment is, the higher the potential return will be. Conservative funds, for instance, will have more lower-risk assets, so their long-term return is likely to be lower. In comparison, aggressive funds will have a greater proportion of higher-risk assets, so they are likely to result in higher returns over time. But they can also fall in value to the same degree.
To choose the best investments for your circumstances and risk profile, you need advice tailored just for you. Talk to a Financial Adviser for guidance on how to get started.
Things you should know.
The material on this webpage is provided for information purposes only and is not a recommendation or opinion in relation to investments.