Iam about to start an investment segment on this site. My recent research has been on diversifying my portfolio (I will explain what that is here), and investment avenues available in Kenya. I am hoping to share some of my findings in due course, as well as other investment issues for your personal finance management. The first step though is to explain some of the basic investment terms you should know.
My list is not as exhaustive as it needs to be, so I will keep updating it with time. But for now, here are some of the basic terms you need to start acquainting yourself with.
The types of Investments
The first rule of investing is to invest in what you understand, and you cannot do this if you don’t know the different types of investments. Once you have a clear understating of every investing option, you will have a better grasp of what option suits your future financial goals.
Stocks/ shares/ equities are ownership units that give an investor stake in a particular company. The number of shares you have represents a percentage of your ownership in that company. That means you get to enjoy the company’s profits if any through dividends or even sell at a higher price to other investors.
Bonds are like loans, where you loan money to the bond issuer like corporates or governments for a specified period and interest, known as the coupon rate. The interest is usually paid back in intervals for that specified period, sometimes annually, or semi-annually. At maturity, the issuer pays back the principal amount in full.
It’s an investment in real or tangible properties like land and buildings. These earn you returns like rental income or capital gains when you sell the property at a profit.
Cash and Equivalents
Cash equivalent investments is considered ‘as good as cash” since its easy and fast to convert them back to cash, like money market funds.
There are different structures for investing, which mainly include;
A mutual fund is an investment strategy that pools together money from different investors to create an investment portfolio. Mutual funds usually have portfolio managers who actively manage the fund in a bid to outdo an index. The portfolio will include shares, bonds, and other securities.
The buy and sell orders of mutual funds are collected during the day. However, the execution happens at the end of the day, after the closing of the market. It ensures that investors do not take advantage of the changes in NAV (Net Asset Value).
Index funds are a type of mutual fund but are passively managed, leading to lower costs. These funds track or mimic a particular market index and hold stocks of companies in that specific index.
Exchange-Traded Funds (ETFs)
ETFs are also a form of pooled fund investment and hold a wide variety of underlying assets or securities in a particular niche. The difference between ETFs and mutual funds is in trading strategies, where ETFs trade during the day on a stock exchange, like regular shares.
Real Estate Investment Trusts (REITs)
REITs are companies that own, operate, or finance real estate investments that generate regular income. These real estate investments could be in hotels, apartments, offices, warehouses, shipping centers among other commercial real estates. Investors pool funds for investments and receive dividends without having to deal with the buying, financing, or management of the properties on their own.
Other Investment Terms
An asset is a resource that earns you a return or money. In investments, assets include bonds, shares, or real estate.
It’s a group of financial assets held by an individual or institution to earn a return and minimise risks. Think of it as a basket that holds your investment assets. For example, if you have invested in bonds and shares from different companies, all these investments, bundled together, make your portfolio.
This is an investment strategy for distributing or allocating different assets in your portfolio. The goal is to balance the risks in your portfolio by allocating assets based on your investment goals, horizon, and risk tolerance. That could mean including bonds, shares, and alternative assets in your basket.
Diversification is a risk management strategy where you allocate different proportions of asset classes in your portfolio. For example, instead of holding one type of share or bond, your portfolio will have many, like mixing corporate, government, and foreign bonds in various percentages. You can also diversify the stocks you hold in terms of sectors or industries.
The concentration of any assets will affect your returns and your overall portfolio performance. Remember, the goal of holding a portfolio is to reduce risks. Diversifying the assets you hold in a portfolio does this since investment assets have different rewards and risks.
It’s the level of risk or uncertainty you are willing to take in any investment. Your risk tolerance enables you to know how much of a loss you can stomach, and what investment assets suit you.
This is the rate at which prices of securities or stocks change within a given period. High market volatility means the prices change rapidly within a short period.
Your net worth is the value of your assets less your liabilities, or what you owe. It can help you gauge your financial health, where the goal is to have a positive net worth. That means your assets are more than your liabilities.
A stock exchange is an organized market where securities like bonds and shares are traded. A good example would be our very own Nairobi Securities Exchange (NSE) or the New York Security Exchange (NYSE).
This is a portfolio of securities representing a particular section of the stock market. For example, there are different indices at NSE, one being the NSE20. The NSE20 index tracks performance of the best 20 performing securities at the NSE.
Investing can be an overwhelming endeavour, especially when you have no idea what the terms mean. But, with a better understanding of basic investment terms, you will have a better grasp of your investment needs and the market.
Learn more about the best investment vehicles for a beginner.