What kinds of investments are available?
There are three main kinds of securities you can invest in - fixed interest securities, shares and managed funds.
Fixed interest securities
You lend someone money, they pay you interest for the use of the money and agree to pay your money back on a certain date. These are also known as debt securities.
Bonds, bank accounts and term deposits, credit union and building society investments, and finance company debentures are all fixed interest securities.
Fixed securities generally pay you an agreed rate of interest at set times. The interest can be paid in various ways. It may be:
- paid to you at regular periods during the term of the investment; or
- paid in a lump sum at the end of the investment; or
- calculated at regular periods and added to the amount you have invested. This is called compound interest. Find out more about compound interest at www.sorted.org.nz
Retail deposit guarantee scheme
Some fixed interest investments, and most bank deposits are covered by the Government's retail deposit guarantee scheme.
Under the scheme, the Government guarantees existing and new deposits in approved financial institutions. So if an approved financial institution goes bust you will get your deposit back, along with the interest due.
The guarantee covers investments such as savings and current accounts, term deposits and debentures.
All the major retail banks, and many credit unions, building societies and finance companies have gained approval to join the scheme.
The guarantee does not cover other investments with these institutions - including shares, managed fund, superannuation schemes, unit trusts, and insurance schemes. However, some cash-only collective investments may be covered.
The guarantee is capped at $1 million per person. It applies until 12 October 2010, meaning investments are only guaranteed up until that date. The guarantee will not cover any default after 12 October 2010, even if the investment was made during the guarantee period.
If an institution defaults and the guarantee is called on, the principal sum borrowed will be paid back along with interest to the date of default, subject to the $1 million cap.
The Government introduced the scheme to ensure continuing depositor confidence in New Zealand, given international financial market turbulence.
Before you invest, ask the institution whether your investment will be covered by the guarantee, or check for yourself by viewing the list of approved institutions on the Treasury website. The site also has answers to common questions about the scheme, including how it applies to family trusts, businesses and what happens if you need to call on the guarantee.
Types of fixed interest securities
There are many different types of fixed interest securities. Generally the higher the interest rate, the greater the risk. The Government, banks, finance companies, companies, credit unions and building societies all offer fixed interest securities.
Government
The Government offers fixed interest investment in Kiwi Bonds through the New Zealand Debt Management Office. Kiwi Bonds are very low risk because the interest payments and the repayment of your money is guaranteed by the Government. This is reflected in Kiwi Bond's credit rating of AAA, which is the highest possible.You buy Kiwi Bonds for terms of six months, one year or two years. You can't trade Kiwi Bonds, but you can transfer ownership to someone else. Read more at http://www.nzdmo.govt.nz/kiwibonds/.
Registered banks
Banks offer a wide range of fixed interest products e.g. savings accounts and term deposits.When you invest the bank uses your money to lend to someone else at a higher rate of interest than they are paying you.
A financial institution can call itself a bank only if it's registered with the Reserve Bank of New Zealand (RBNZ). Registered banks are supervised by the RBNZ and must comply with the conditions of their registration. Read more at www.rbnz.govt.nz
A bank must maintain a credit rating issued by one or more of three credit rating agencies. It must have an investment statement which explains the term deposits and a general disclosure statement which explains the bank's financial position. Banks also must publish a key information summary of their financial performance and risks every three months. If you ask for these documents they must give them to you.
The RBNZ monitors how registered banks comply with their conditions of registration, but neither it nor the Government guarantees that a registered bank will not get into difficulty or fail.
Finance companies
Finance companies also offer fixed interest securities. They take in your money and lend it out for various ventures.Finance companies come in various shapes and sizes, and the risk of their investments varies as well. Some investments with finance companies are covered by the Government's retail deposit guarantee scheme.
The collapse of several finance companies in recent years, and the losses incurred by their investors, highlights the importance of understanding the risks before you invest.
An example:
An investment of $5000 in a registered bank for a year is paying 6% interest. At the same time an investment of $5000 in a finance company for a year promises a return of 9%. That extra 3% return is a 50% increase in interest and usually reflects a similar increase in risk.
Finance companies must have an investment statement and prospectus which explain the investment. You should read the investment statement and read, or at least ask about, the main points in the prospectus. These should tell you about the people the finance company is lending your money to. This will help you assess whether the interest offered makes up for the risk of the investment.
If you are thinking of investing in a finance company ask what your investment adviser knows about the skills and track record of the directors and managers running it.
The finance company must also have a trust deed that sets out what the company can do with investors' money and a trustee whose job is to look after investors' interests.
Most finance company investments are for a fixed term. Usually this means you can't withdraw your money until the end of the term even if the company's financial position deteriorates. If you can cash in the investment early you will probably have to pay a fee.
In 2008 significant laws were passed to increase regulation of finance companies, which will come into force in stages through 2009-2010. The changes include minimum capital and governance requirements, and a requirement to provide a credit rating from an approved rating agency.
Companies
Some companies offer fixed interest securities, particularly bonds and debentures. Corporate bonds have become more popular since the global financial crisis began, as companies seek alternative sources of funding and investors hit by lower bank deposit rates turn to higher earning investments.
But as with other investments, it is good to remember that higher promised returns usually indicate higher risk.
Before you buy a company bond you need to have some understanding of what the company does, the industry it operates in and how it might be affected by local and international events. You also need to understand how strong it is financially - what assets and debts it has, and how profitable it is.
It's also important to look at the ranking of bonds (where you stand in the queue of debtors waiting to be repaid), the security behind the bonds - if any - and the term of the investment. Some bonds have interest rates that can change , or 'reset' during the term of the bond, and it's important to understand if this is the case.
This will help you gauge the company's ability to make scheduled interest payments and repay the principal on time.
The offer documents should include most of this information, or you can get independent advice. An independent credit rating from well-known agencies such as Fitch, Moody's and Standard & Poors can also help you assess. The financial strength of a company.
Bonds listed on the NZX or an overseas stock exchange can be sold more easily, have additional regulatory protections and the transparency of a listed market.
Credit unions and building societies
Building societies and credit unions provide services and offer fixed interest securities, similar to a registered bank.They must have prospectuses and investment statements that explain the investments. They must give you these documents if you ask for them.
They are not registered or supervised by the Reserve Bank of New Zealand. However, they are supervised by trustees who are appointed to look after the interests of investors.
A fee may be charged if you want to get your money back before the fixed term is up.
Shares (equity securities or stock)
When you buy shares you buy part of a company. As a shareholder in the company you may be paid a dividend on your shares. You might also be able to sell the shares later. If you sell for more than you paid for them you make a capital gain on your investment. Of course, there is a risk that the value of the shares may fall.
Listed companies
When a company wants to raise money to develop or expand it can list on a stock exchange, such as the New Zealand Exchange (NZX). When you buy shares in that company you contribute some of the money the company wants in exchange for those shares.To buy shares in New Zealand and overseas companies that are traded on a stock exchange you need a sharebroker. Companies that are listed on an exchange, and brokers who are "market participants" (i.e. are registered with the exchange) have to comply with the rules of the exchange. This provides some protection for shareholders.
A sharebroker charges brokerage when you buy shares. This may be a proportion of the amount you spend or it may be a flat fee for each trade.
Some brokers provide research and analysis and advice as well as trading your shares. Others provide a trading service only. You can find sharebrokers listed in the Yellow Pages and under Market Participants at www.nzx.com.
Share prices rise and fall over time so you will lose money if you sell when the price is lower than the price you paid for the shares. The current price of listed shares is readily available on the internet at www.nzx.com and in the newspapers. This allows you to watch and see how share prices change over time.
Unlisted companies
You can buy shares in companies that are not listed on the New Zealand Exchange (NZX) or an overseas exchange.If the shares are not traded on an exchange it is likely to be harder to sell your shares. Also the companies and trading activity are not subject to rules that protect investors (like insider trading and continuous disclosure laws).
Managed funds
Money from individual investors is pooled and invested by a fund manager.
Superannuation schemes, unit trusts, group investment funds (GIFs) and some life insurance are managed funds. If you join KiwiSaver you will be investing in a managed fund.
When you put your money into a managed fund the investment decisions are made for you by the fund manager. Because there is a large pool of money to invest the manager can usually get better deals than any one person.
The fund manager puts investors' money into a range of investments, such as shares, debt securities and property, both in New Zealand and overseas. This means that when you invest in a managed fund you spread your money over a range of different types of investments and different countries. The types of investments the manager can choose are set by the particular fund's trust deed.
You can pick a managed fund with lower, medium, or higher risk depending on the level of risk that suits you. Read more about risk and your risk profile.
You pay fees when you invest in a managed fund. Different funds charge different fees and they can be quite complicated. For example, there may be an initial fee when you first invest in a fund, an annual management fee, and an exit fee when you cash in your investment. Some managed funds also charge separate administration fees.
Ask what fees you will be charged before you sign up to invest and before you pay any money. An investment adviser should be able to help you compare the fees charged by different funds.
Types of managed funds
Unit trusts, group investment funds (GIFs) and superannuation schemes are the main types of managed funds.When you invest in a unit trust or a GIF you buy "units" which represent a share of all the assets owned by the fund. As well as the fund manager, the fund will have a trustee to look after the assets for investors.
For GIFs the trustee may also manage the fund, or it may be externally managed. The value of your units in a unit trust or GIF will go up or down as the value of the fund's investments changes.
Some managed funds are listed on NZX or overseas stock exchanges. You can buy and sell units in these funds.
If you have units in a managed fund that is not listed on a stock exchange you can usually sell them back to the manager. However, you should check whether there are any restrictions on this.
Superannuation schemes are specifically designed for people who want to invest to provide for their retirement. Investments in these schemes are often locked in until you retire. KiwiSaver schemes are superannuation schemes. You can find out more about superannuation, and KiwiSaver, at www.sorted.org.nz
Other investments
There are other securities investments you can buy. These include collective property schemes, contributory mortgage schemes, agricultural and forestry schemes, and futures contracts.
If you are interested in any of these it would be wise to contact an investment adviser.
How can I get my money back?
One of the facts you need to know before you decide on an investment is how you can get your money back. This depends on the type of investment.
Fixed interest securities
Some fixed interest investments are "on call". This means you can get your money out at any time.Other fixed interest investments are for a set term, such as a one year deposit. When you invest for a term the issuer (i.e. the person or institution offering the investment) does not have to repay you if you want your money back before the term is up.
If the issuer does allow you to take your money out early, there is likely to be a penalty and/or a fee.
Fixed interest investments, such as bonds, that are listed on the NZX or an overseas stock exchange can be sold more easily.
Shares
Shares that are listed on a stock exchange can be sold at any time provided there are buyers for the particular company's shares. Whether you sell at a gain or a loss depends on the price you paid for the shares and the price they are trading at when you want to sell.Shares that are not listed on a stock exchange may be harder to sell because there may not be a buyer when you want to sell.
Managed funds
If a managed fund is listed on the stock exchange you can sell your units in the same way as you can sell shares.With most other managed funds you can get your money out by selling your units back to the manager of the fund, but there may be some restrictions on this. The amount you get will depend on the value of the units at the time. There may be a fee to pay.
Investments in superannuation funds are often locked in until you retire. If this is the case you usually can't get your money out early.
