Key Concepts to Understand When Starting Your Investment Journey
Investing can seem intimidating at first, especially with all the jargon and technical terms floating around. But the truth is, with a little knowledge and clarity, anyone can start making informed decisions to grow their wealth over time. Whether you are just starting out or wanting to deepen your understanding, there are a few essential concepts every investor should know. These foundational ideas will help you not only understand how investing works, but also how to choose the right options for your goals.
One of the most important concepts to grasp is inflation. Inflation refers to the gradual increase in the cost of goods and services over time, which reduces the purchasing power of your money. For example, if inflation is 6% per year, something that costs R100 today will cost R106 a year from now. This means that if your investment does not grow by more than 6% in that same year, you are effectively losing money in real terms. That is why it is critical for investors to aim for returns that beat inflation, so that their money retains and grows its true value over time.
Closely linked to inflation is the idea of interest. Interest is the reward you earn for lending your money or the cost you pay for borrowing money. When you invest in interest-bearing products like fixed deposits or government bonds, you are essentially lending money to a bank or the government, and in return, you earn a set interest rate. Understanding whether this interest is simple or compound is also key. Compound interest means you earn interest on your interest, which can significantly grow your investment over time. For example, R10,000 invested at 8% compound interest annually will grow much faster than the same amount earning 8% simple interest.
Another foundational concept is understanding investment products. These are the vehicles or “containers” through which you invest your money. Examples include unit trusts, retirement annuities (RAs), tax-free savings accounts (TFSAs), and endowment policies. Each product has its own rules, tax implications, fees, and liquidity options. For instance, a tax-free savings account allows your money to grow without being taxed on interest, dividends, or capital gains, but there is a limit to how much you can contribute. A retirement annuity, on the other hand, comes with tax benefits for contributions made, but locks your money away until at least age 55.
Within each investment product, your money is usually invested in different asset classes. Asset classes are categories of investments that behave similarly in the market. The four main asset classes are equities (shares), fixed income (bonds), property (real estate), and cash or money market instruments. Equities typically offer higher potential returns over the long term but come with more risk and volatility. Bonds and money market instruments are more stable but generally yield lower returns. A balanced portfolio includes a mix of asset classes based on your time horizon and risk tolerance. For example, someone saving for retirement in 30 years might be more heavily invested in equities, while someone nearing retirement might shift towards lower-risk bonds and cash.
It is also useful to understand the role of product providers. These are the institutions that create and manage the investment products, such as Allan Gray, Ninety One, Coronation, or Sygnia in South Africa to name a few. They select the underlying investments and manage the portfolios, usually charging a fee for their service. Choosing a reputable product provider is important, as it affects the quality of investment management, transparency, reporting, and customer service you will receive. It is often beneficial to compare fees and historical performance across different providers before making a decision.
Other important concepts include risk and return, which go hand in hand. Generally, the higher the potential return of an investment, the higher the risk involved. Understanding your own risk tolerance (how comfortable you are with market ups and downs) will help you choose investments that align with your emotional and financial comfort levels. For instance, someone with a low risk tolerance might prefer money market funds or bonds, while a more aggressive investor might favour shares or listed property.
Another concept to be aware of is diversification. This is the practice of spreading your money across different asset classes, sectors, and regions to reduce overall risk. Instead of putting all your eggs in one basket, diversification ensures that if one investment performs poorly, others may balance it out. This approach is often used in unit trusts and exchange-traded funds (ETFs), which pool investors’ money and invest in a variety of assets.
Lastly, it is worth understanding liquidity, which refers to how easily you can access your money. Some investments, like shares or money market funds, are relatively liquid, you can access your funds within a few days. Others, like retirement annuities or fixed-term deposits, may restrict access until certain conditions are met. Knowing how and when you can access your money is crucial, especially when planning for short-, medium-, and long-term goals.
Investing is not just about chasing high returns, but rather about making informed decisions based on sound principles. Understanding how inflation eats into your money, how interest can help it grow, what types of products and asset classes are available, and how providers manage these investments all form part of the bigger picture. By familiarising yourself with these concepts, you are not only taking control of your finances, but you are also setting yourself up for long-term success.
