Getting savvy with savings

Saving is one of the smartest ways to secure your future and be more confident in your finances. 

But you might be able to make more of your money without adding another dollar.

Understand investments

Investing is one of the best ways to really make your savings work for you over the long term.  This is important as inflation can eat into your long term savings if the returns you get don’t keep up with the cost of living.

Investing means putting your money into financial products or other things that offer a way to make money on top of what you’ve put in. Different investments offer different potential returns, with different levels of risk. 

Investments that grow your savings – such as shares – tend to have more ups and downs in the short term.  But over the long term these should give you better results than having your money sitting in a cash account just earning interest.

Spreading money across a range of different types of investments – 'diversifying' – is a good way to reduce some of the risks of investing. Some investments will tend to do well when others do badly, and this helps to smooth out some of the shorter-term bumps.

Thinking about your goals, and how long before you need to start spending your savings, is important in choosing the right mix of investments. Generally speaking, the longer your timeframe, the more of your money you may be able to put in investments that grow.

To choose the right investments, it’s also helpful to understand a bit about what’s out there.

Term investments

Term investments and term deposits are a special type of investment that usually pays a higher rate of interest than ‘on-call’ savings. The investment pays you a pre-determined or posted rate of interest for a set period of time. This is typically for a period of between 1 month and 5 years.

The interest earned on your initial money deposited can be paid out to you at frequent intervals, such as monthly or quarterly throughout the life of the term. Or it can be paid out to you fully at the end, on the 'maturity' date, along with the principal amount invested.

Funds placed in a term investment or deposit usually cannot be taken out before the maturity date and this is why the interest rates offered are typically higher than ‘on-call’ money. However, early withdrawals can be permitted, but a penalty ‘break’ fee or a lower interest rate – or both – may be applied

Bonds

Bonds are issued by companies, agencies and governments to raise money. Just like with a term investment or deposit, if you buy a bond, you are lending the issuer your money and they agree to pay you your money back on a set date and pay you interest along the way. Most bonds pay a set ‘coupon’ interest rate at regular intervals. This makes them suitable for investors who are looking for some certainty of income and is why they are sometimes called ‘fixed interest securities’.

Bonds are considered a more conservative investment than shares, but they do still carry some risks. Unlike term investments or deposits, the value of bonds changes as interest rates change. If interest rates rise and you want to sell your bond before its maturity date, you may get a lower value. This is similar to the ‘penalty’ fee that might apply with a term deposit being broken before maturity.

Government bonds are usually safer than other bonds, but will pay a lower interest rate as a result.

Bonds issued by companies can sometimes have different rankings. A ‘senior’ bond means that, in the event of the bond issuer failing, investors will be higher priority in the queue of people trying to get their money back. ‘Subordinated’ bond investors will have a lower priority.

Bonds can face ‘liquidity’ risk. That means that if you want to sell your bond you may not be able to find a buyer.

Some bonds or bond issuers have credit ratings. This is an independent assessment of the probability that the issuer can’t make payments on its bonds. Having a credit rating does not automatically mean an investment is a safe one.

Shares

Shares are issued by companies as another way of raising money. Buying shares in a company is buying a part of that company. As a ‘shareholder’, you are also a part owner of the company. You can own shares directly or through managed funds like KiwiSaver.

The price of the shares can go up and down, and some companies' share prices can move a lot more than others. Companies with share prices that move up and down more than others usually reflect the type of business they are in. For example, shares in banks and electricity companies will tend to be more stable than those of fast-growing technology companies.

If a company makes more money, then the price of the shares of the company should increase. The company may then choose to share some, or all, of its profits with you as a part owner. Money paid to owners from profits is called a 'dividend'. Paying dividends usually happens once or twice a year.

In general, it is expected that share prices will rise over the long term and that the shares can therefore be sold in the future at a higher price. However, if the company makes less money, it becomes less valuable. Its shares may then be worth less money, and less than what you paid for them if you need to sell them.

Property

Buying property is a very popular investment for New Zealanders, especially through home ownership. There are a number of other ways to invest in property too – including land, rental or investment houses, and commercial properties, such as office buildings, shops or warehouses.

There are two main ways to make money out of investing in property. You can:

  • rent it out and receive rental income
  • make money from the property increasing in value.

Like any investment, the change in any property’s value depends on the demand and supply. For example, if a suburb gets re-zoned to be in the catchment area of a highly regarded school, more people might want to buy a house in that area, which would lift the prices.

Property is usually considered riskier than term deposits and bonds, but less risky than shares in companies. The main reason for this is that the income earned from property – rent – can fluctuate:

  • more than the income earned from term deposits and bonds – which are fixed
  • but typically less than the profits of companies.

Investing in property is usually a long-term investment. Selling the property can take weeks or even months to complete, so property investing is 'illiquid'. Instead of selling, you may be able to get some money out of your property by asking your mortgage lender to increase the mortgage.

Managed funds and KiwiSaver

Managed funds are investments which pool the money from a lot of investors. For smaller investors, they are a very good way of getting a spread of investments – or ‘diversification’. This removes some of the risk of investing directly into only a small number of investments.

A professional manager invests the money in the fund, so you don’t have to do it all yourself. You’ll usually pay a fee to have your money managed this way.

Managed funds can concentrate on certain asset classes or markets, like technology stocks. Or they can be spread across a range of different asset classes, such as shares and bonds, both in New Zealand and overseas.

Managed funds will have different risks, depending on what they invest in. For example, some mostly buy shares and property and are more risky – these are often called ‘growth’ or ‘aggressive’ funds. Others mainly buy bonds or fixed interest investments – these are often called ‘income’ or ‘conservative’ funds. Balanced funds typically have an equal amount of growth and income investments.

KiwiSaver is a kind of managed fund. When you join KiwiSaver, you can choose the provider and type of fund you’d like to invest in, to best suit your own risk profile and goals.

Currency

Whenever you invest money overseas, you are investing in foreign currencies, as well as the underlying asset you are buying.

This can be another good and sensible way to spread your risks away from New Zealand. We all tend to spend some of our hard-earned money on imported goods and services. Having some currency investments helps to offset the impact that a sudden fall in the value of the New Zealand dollar would have on the price of these imports!

Currencies can also be referred to as foreign exchange, which is often shortened to ‘forex’.

Sometimes when investing overseas, it may be best to not have the investment in the foreign currency as well. Foreign currency exposures can be ‘hedged’, which means protecting the overseas investments from a fall in the value of the foreign currency. However, if the currency is ‘hedged’, you would also miss out on any currency gains you would get if they were ‘unhedged’.

Fund managers will typically ‘hedge’ some or all foreign currencies from time to time as part of their professional management of overseas investments.

Derivatives

A derivative is another way to gain exposure to something. It’s a contract to be met at a pre-determined time in the future. Its value is ‘derived’ from the value of something else, which is where it gets its name from. ‘Options’ and ‘futures’ are kinds of derivatives.

Derivatives are complicated but one use of a derivative is to protect – or 'hedge' – yourself from price rises in the future. For example, a chocolate company might think the cost of cocoa beans will rise next year because the crop has suffered this year. It wants to protect itself from paying more for its cocoa beans in the future, so it agrees with its supplier that it will pay the current price now for next year’s beans. This is using a ‘derivative’ contract in practice.

If the price of beans goes up next year, the company will have maintained its costs at this year’s level and may not need to put its own prices up. This might be good for their own chocolate sales if their competitors haven’t used derivatives and have to put their chocolate prices up! However, if the price of cocoa beans goes down instead, the company would have paid more than it needed to for the beans. It may have to keep its own chocolate prices the same and be less competitive with other chocolate-makers.

Most investors in derivatives are professionals, including fund managers. They typically use derivatives to manage risks or gain exposure to investments that may not be possible with typical normal investments.

Collectables, peer-to-peer lending and crowdfunding

You might choose to put your money into things that are not traditional financial products. 

There are different reasons for buying these investments, but, as with all investments, their value can go up or down and there are other specific risks.

Collectables

Examples of collectables are items like art, fine wines or rare coins. Often the main reason people buy collectables is because they love them, not because they necessarily believe their collections will be valuable in the future.

Peer-to-peer lending

In peer-to-peer lending, small investors lend money directly to those people who want to borrow money, effectively removing a middle agent, like a bank. The lenders and the borrowers agree the terms between themselves, like the interest rate and the date the loan has to be repaid.

The amount of security available if the borrower defaults may be limited, so be careful!

Equity crowdfunding

In equity crowdfunding you contribute a small sum to a company that’s just starting out. The company gets small amounts from lots of people, so it can add up to a larger pile of money to use in their business.

You might get shares in the company or you might get the product early or become a special customer.

But if the company fails, as a few start-ups do, you might lose all of what you’ve invested.

Alternative asset classes

Outside the ‘normal’ investment types of cash, bonds, shares and property, there are heaps of other asset class possibilities, which are referred to as ‘alternative’. Each one has its own unique features, so they can get complicated quite quickly. You usually need to be pretty expert before investing in them, so you’re aware of exactly what you’re going to get yourself into.

The main types of alternatives are commodities, private equity and hedge funds.

Commodities

These are actual things – like gold, coffee and oil – that are traded across the world.

You don’t get interest or dividends when investing in commodities – you are fully banking on a price movement. For example, if you think that the price of oil is going to go up, you could buy oil and then you would benefit if the price of oil increases. If the price decreases, you’ve lost money.

There are different ways to invest in commodities so make sure you know what you’re getting into before you get into them.

Private equity, hedge funds and hybrids

There are lots of other types of investments you can put your money into. For example, you may have heard of private equity and hedge funds, which can offer great returns. But generally they have higher risk and are more expensive than managed funds.

They also:

  • tend to have minimum investment timeframes, usually of at least a few years
  • are not very liquid
  • are valued on an infrequent basis – monthly, quarterly or even only annually.

There are also capital notes, perpetual subordinated notes and other hybrid securities, which mix elements of bonds and shares.

If you’re thinking about these alternative investment products, you’re likely to be an experienced investor but it’s still wise to talk to an Authorised Financial Adviser before putting your money into them.

What’s next?

Maybe you’re hoping to become a home-owner in the next few years. If that’s you, read more about buying your first home.

Remember, this is just a guide to help you start thinking about your finances and is not financial advice. If you’d like to talk with an Authorised Financial Adviser who can look at your situation, we can put you in touch with someone in your area.

Find out more