If you’ve ever earned interest in a bank account, you are an investor. I define 'investing' as setting aside money where it can grow by earning 'returns'. Instead of spending it now, you can spend it later, and hopefully, you’ll have more to spend. So what’s a return?
The Four Main Types of Investing
Interest: The money your bank pays you, for example, on a term deposit. It’s your reward for letting the bank have the use of your money for a while.
Rental income: If you invest in a rental property, your tenant will pay you rent – or at least you hope they will!
Dividends: If you own shares in a company, you own a small portion of the company. When the company makes a profit, it often keeps some of the money to grow but gives some back to shareholders as a dividend.
Gains: If you invest in property or shares or any other asset whose value can go up and down, and you sell it for more than you paid for it, that’s a gain. Sometimes, of course, you’ll sell at a loss, which is a negative return. In a bad period, for example, your return might be minus 10% or more. The idea is to earn total returns that are higher than any fees, tax or other expenses you have to pay on the investment.
What about bonds?
So far we’ve mentioned term deposits, shares (sometimes called equities or stocks) and property. Another common investment is bonds. These are issued by central and local governments and companies. Bonds are rather like term deposits. You give the government or company your money for a period, and they pay you interest at regular intervals during the life of the bond. At the end, you get your money back – unless the issuer defaults.
These include commodities, Bitcoin, gold, art and other collectibles. Most of these come with considerable risk, and usually work only for those who know what they’re doing – and even then the outcome isn’t always good. They’re not for beginners! What about KiwiSaver? We’ll look at that in our next myth.
Upside Down Investing
Paying off a debt has the same effect on your wealth as investing does. Getting rid of a negative is like adding a positive!
Let’s say you have credit card debt that’s too big for you to pay off with your next payment. You might be horrified to know that you’re likely to be paying interest of around 20%.
But here’s the thing: paying off a credit card debt that charges 20% improves your wealth as much as an investment that earns you 20%. Wow! What’s more, it’s 20% after fees and taxes. And it’s risk-free.
If you have high-interest debt, make getting rid of it your first ‘investment’. Set a goal of paying down the debt over, say, the next few months. You’ll end up much better off.
Does this apply to a mortgage?
If you make extra payments on a 3% mortgage, that improves your wealth as much as an investment that pays a 3% return after fees and tax. That’s still not bad for a risk-free investment.
On the other hand, paying a mortgage down fast often takes years. Meanwhile, you’re not benefitting from spreading your risk over different types of investments. And you’re not learning about how investing works – really useful knowledge to build up for later in life.
So I recommend that people with mortgages also invest through KiwiSaver, contributing enough to get all the government and employer contributions. Beyond that, it’s good to put spare money into getting rid of your mortgage as soon as you can.
Note: If you have a fixed rate mortgage, there may be limits to how much extra you can pay off without penalty while you’re in the middle of, say, a two-year term. Check with the lender. But you can always pay extra at the end of each term.
Does this apply to a student loan?
If you’re living overseas, and therefore paying interest on the loan, get rid of it as soon as you can. But if you’re living in New Zealand, the loan is interest-free, so it’s different. If you’re working, you’ll be paying down your student loan through payroll deductions. There’s nothing wrong with making further payments to get rid of being in debt, but there’s no big rush to do that.
This content is reproduced from ‘Hits and Myths: an introductory guide to investing by Mary Holm’.
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