Basic investment questions you were too embarrassed to ask

Snowball Effect's head of private capital Cowan Finch answers a few basic questions that still leave many baffled. Photo/Supplied.

Opinion

Between stock market crashes, new cryptocurrencies and hidden Kiwisaver fees it's a confusing time to be an investor. All the jargon can be scary for first timers and even investors who are experienced in one type of investment can struggle when trying out a new type of investing. Here's a quick tour through some of the most basic investing questions that you might have been too embarrassed to ask.

What's compound interest?

Savings accounts are the first type of investment that most people start with. They usually offer lower returns than other types of assets because they're lower risk, but the interest that you do earn will compound over time. The key thing to understand about compound interest is that you will earn a return on your initial investment, as well as all the interest that you have already received. At first, the additional interest is a very small amount, but over a long time period, it can grow to be the largest portion of your return. The principle of compounding also applies to other types of investment where your initial principal is combined with the returns and reinvested so that any gains continue to grow over time, such as your KiwiSaver or shares with dividend reinvestment plans.

What's an index fund?

A passive index fund is an easy way to invest in a lot of different investments all at once. This is a common type of Kiwisaver fund and you can also invest directly into an index fund. These types of funds usually have lower fees than managed funds and you can choose from lots of different types of index funds such as New Zealand shares, overseas shares or a mix of different types of assets.

What's a managed fund?

A managed fund is a pooled fund of investor money, managed by a professional investment firm. The firm typically charges a fee for investing the funds on behalf of the investors. There are a variety of managed funds that target specific countries, different asset classes, or even specific types of assets within asset classes such as private company shares in New Zealand.

How do shares in a company work?

Shares are a way of keeping track of who owns what portion of a company. The shares are recorded in a share register and the number of shares you own represents your ownership portion of the company. You can earn money on shares when the company does well and pays out part of their profit as dividends to shareholders or when you sell your shares to someone else.

What's the share market?

Some companies are listed on a stock exchange such as the NZX so that investors can buy and sell shares in the company. There are rules about getting and staying listed on a stock exchange. The rules are designed to help keep a level playing field for all investors. The price of shares on the stock market goes up and down depending on the supply and demand in the market on that day. In theory, the share price should track the underlying value of the company itself, but the markets can have a mind of their own.

How do shares in private companies work?

Private company shares are most commonly purchased directly from the company to help the company grow. You will own shares in the company just like a public company but it is not as easy to sell the shares because they are not listed on a stock exchange. Private companies tend to be long-term investments because it can take five to ten years for a company to grow large enough that they can pay dividends or be acquired by a larger company. In some instances, shares in a private company may have different rights which can influence their value.

What's a cryptocurrency?

Bitcoin and other cryptocurrencies are digital tokens where the eventual supply of tokens is limited. The limited supply allows the tokens to be exchanged between people as a form of currency. The markets they are traded on are unregulated so the usual rules don't apply. Investing in digital currencies is a lot like investing in other currency markets, as it's hard to really know what will go up and what will go down. And it's easy to lose a lot of money very quickly.

Cowan Finch is the head of private capital at Snowball Effect