There are advantages and disadvantages of every investment whether it be cash in the bank, in shares or bonds. The question should not be “which one should I put my money into” but rather – “how much of my money should I allocate to each?”.
Best practise when investing is to spread risk by diversifying your investments across different asset classes, such as Cash, Fixed Income/Interest, Property and Shares/Equities and within each asset class by industry sectors and geography.
The spread across these different asset classes (your asset allocation) will vary depending on your risk profile. If you are a conservative investor and don’t want to take a lot of risk, your portfolio would contain a larger percentage of cash and fixed interest and fewer shares/equities.
It is also standard investment practice to manage risk by diversifying a portfolio across a number of investments within each asset class. For example, within shares, an investor will usually hold a number of different companies from different sectors. If one sector is performing poorly, this may be offset by other sectors performing more strongly.
Certain sectors may be stronger in some countries than others, and therefore it is important to look at, not only what sectors to invest in, but also where.
In New Zealand we have a strong primary and energy sector, but to gain exposure to the technology sector for example, may require you to invest globally. By investing in overseas securities you will get exposure to a different economy and sectors, which may not be available locally.
Diversification by geography is also important in order to manage risk and mitigate the impact of poorly performing markets, whilst taking advantage of better performing markets. Whilst one country may be in decline, another might be enjoying growth and this can help provide positive returns.
The mechanics of a Fund
When investing in a fund investors purchase a unit (a part of that fund). You invest in a fund with the expectation of receiving a return each month depending on how the fund has performed.
Your return from a fund is a reflection of the increase in value of the unit price. An increase in the unit price is driven by receipts of dividends and interest payments and the increase in market value of the investments held by the Fund.
Investment funds are typically named and categorised by the investments they are made up of.
Some funds are diversified and thereby include a combination of different types of assets classes (cash, shares, fixed income etc) to cater for different risk appetites (e.g. Conservative, Balanced or Growth).
The risk within each of the funds is determined by the percentage that is invested in each asset class.
Consequently, a growth fund for example, will include a higher percentage of shares (referred to as a growth asset) than a Balanced or Conservative fund which will have a higher percentage of income assets (cash and bonds).
Funds can also be focused on a particular asset class (Fixed Income, New Zealand Equities, Australian Equities etc) or be designed for a specific purpose (for example income funds or ethical investing funds).
Why invest in a Fund
As funds invest on behalf of a number of individual investors they have much larger values to invest. Hence they can hold more shares, in more sectors and in more markets (broader diversification) than an individual investor could on their own, as this is often uneconomic for smaller investors.
How Investors use Funds
- Smaller investors can use diversified funds, such as the QuayStreet Balanced Fund as the cornerstone of a portfolio; and complement this with direct investments as appropriate. This provides smaller investors with a well-diversified base portfolio, suited to your individual risk profile.
- Larger investors can use funds to gain exposure to a specific asset class, such as International equities, Australasian equities or fixed income, complementing a larger portfolio.