By MARY HOLM
Q: I have read your column a couple of times now and have been thinking about writing for advice but haven't yet had the time.
I would very much appreciate it if you could give me some kind of advice on an appropriate investment for my situation.
I am a 15-year-old home-schooling student in Auckland, I have saved $1155 and earn up to $50 a week.
I have been reviewing my options as to where to invest and I have come up with these: put and call share options, short selling, IPOs, mutual funds and of course ordinary shares.
Which is the best path to take?
I am looking for something with relatively high returns but am aware that's not altogether likely.
My preferred option would be a low-risk, high-gain, short-term investment.
I have chosen short term because I would like to purchase a digital camera in the $1000-$3000 range but still keep a significant investment.
Could you please outline some possible steps I could take. It will be greatly appreciated.
A: I'm not sure what I say will be appreciated.
Just as there's no such thing as a free lunch, there's also no such thing as a low-risk, high-gain investment, especially over the short term.
I have to congratulate, you, though, on your savings, and on the range of investments you're considering. You're certainly adventurous.
Let's look at what you've come up with:
* A put option gives you the right to sell shares in a company at a specified price, called the "exercise price", on or before a certain date.
You would buy a put option if you thought the price of the underlying shares was going to fall.
If the underlying share price doesn't, in fact, fall below the exercise price by the time the option expires, it is worthless. Obviously, nobody would want to buy the underlying shares in the market and then sell them for less than market price.
Any investment that can quite easily become worthless is pretty risky.
The situation is different, though, if you own shares in the company. Having the option guarantees that, if the share price falls, you will at least get the exercise price for your shares.
That's called hedging. It reduces risk. But, to get that insurance, you must pay to buy the option. You lower your risk but, because of the added expense, you also lower your return.
* A call option gives you the right to buy shares at an exercise price, on or before a certain date.
It works in the opposite way to a put. You would buy a call if you thought the price of the underlying shares was going to rise. It guarantees that, at a future date, you won't have to pay more than the exercise price.
But if the underlying share price doesn't rise above the exercise price, you lose money.
It's possible to trade in a few options and warrants, which are like long-dated options, on the New Zealand Stock Exchange.
But most options on New Zealand company shares are traded on the Sydney Futures Exchange.
* Short selling is, basically, selling shares you don't own. Sounds weird, but hang in there.
As with put options, you would sell short if you thought a share price was going to fall.
An example: If you sell short 10,000 Telecom shares, your broker "borrows" the shares from a shareholder we'll call Big Institution, sells them in the market and holds the proceeds on your behalf.
At a later date, you are required to return the 10,000 shares to Big Institution.
You make what are called margin payments to Big Institution for borrowing its shares and to your broker for taking the risk that you will not return the shares to Big Institution and the broker will have to do so.
Furthermore, if the share price rises before the return date, you will have to make larger margin payments to the broker.
If, on the return date, you can buy the shares for less than you originally sold them for - after brokerage and margin payments - you've gained. But if the share price hasn't fallen enough, you've lost.
As with options, you can use short selling to hedge. If you also own shares in the company you are "shorting".
In this case, you would own and short sell Telecom shares at the same time.
If Telecom's price rose, your shareholding would be worth more, but you would lose on the short sale. If its price fell, you would gain from your short sale, but the value of your shareholding would drop.
Again, though, this reduction in risk comes at a price - the brokerage and margin payments.
* Still with me? That stuff gets pretty head-spinning! But we're on to the easy ones now.
An IPO, or initial public offering, is when a company first lists on the Stock Exchange and many investors line up to buy.
Quite often, the share price rises right after an IPO, so you can sell quickly at a profit. But reasonably often, it falls.
By the time you pay brokerage to buy and then sell, and perhaps also pay tax on your gains, there's a pretty good chance you won't make much.
* "Mutual funds" is American for managed funds. These funds pool lots of investors' money and buy shares or property or fixed interest or a mixture.
Their big advantage is that you get wide diversification. Their big disadvantage is that you pay fees.
And in practically all managed funds, and certainly those that bring in high returns, the value of your investment will fluctuate.
* The value of ordinary shares also fluctuates.
So where are we?
In all of your alternatives, there's the possibility of a big gain. But there's also quite a big chance, especially over a couple of years, that you will lose money.
You could use put options or short selling to hedge, which would limit your losses.
But, by the time you paid for that hedging, you could no longer expect to make big gains.
The basic investment rule - that you can't get high returns without taking high risk - always applies.
What's more, many of the alternatives wouldn't be feasible with your amount of money. Brokerage and other costs would eat up too much.
If you want to be sure that your precious savings won't lose value over the next couple of years, go for a fixed-interest investment.
In many cases, you need more than your $1000-odd, but you could get a Kiwi Bond (ring the Reserve Bank on 0800 655 494) or a term deposit from some banks (see www.interest.co.nz for minimum amounts and interest rates).
Because you haven't got $5000 or so, you won't get very impressive interest, I'm afraid.
To do better, you might be tempted to take a little more risk and invest in a conservative corporate bond or capital note. Some have $1000 minimums.
Ask a sharebroker what is available.
But I would avoid bonds and notes that pay high returns.
It's the same old story!
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Q: Your correspondent advocating Sky City shares as the sole answer for every investor is blind to the obvious.
Forget about the current terrorist risk or the disgruntled gambler that might blow the place up.
How about something as simple as the Government raising taxes on gambling, a risk rumoured only some months ago about the time of the election?
No one tells us when the bad news is coming that results in the destruction of a company's share price overnight.
I wish your correspondent and any others following a single stock investment philosophy well.
I will remain diversified, knowing that there is greater certainty that I will attain my financial goals by doing so.
A: Me, too.
In my responses to the Sky City fan, I haven't gone into the specific risks of the company. I've just written generally about the risk of holding any single share.
But your examples of things that can go wrong should make the message clearer.
We could, I'm sure, draw up a similar list for any company - although Sky City, with its iconic tower and the nature of its business, is perhaps more vulnerable than many others.
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Q: Your Sky City advocate likes to gamble on a single share portfolio.
Gamblers usually lose, which is why Sky City makes a profit.
When I've wandered through the Auckland casino I haven't seen happy faces, just grim determination and disappointment.
Personally I'd prefer to invest in companies that don't set out to make profits in such a manner.
A: "Gambling" on a single share isn't quite the same as gambling at a casino.
Most share prices rise most of the time. So those who invest in single shares gain more often than they lose.
It's just that they take more risk than their average gain would justify. It's almost a gamble, I suppose.
Your other point is, as you say, personal.
But there's something to be said for sleeping easily not just because your investments are conservative enough for you, but also because they are ethical enough for you.
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