The long and short of complex investment terms

We broke down some of the key financial terms commonly used in the investment world.

When you are talking about shifts in the country’s economy:

Recession: Real GDP refers to the total aggregate of a country’s economic activity after inflation. A recession occurs when the country’s real GDP (gross domestic production) declines over a six month period or when there are two consecutive quarters where the country sees a fall in GDP.

Repo rate: The repo rate is the interest rate measure that the SARB uses in setting interest rate policy in South Africa. In simpler terms, it is the interest rate at which the SA Reserve Bank (SARB) lends money to commercial banks such as FNB, Absa, Standard Bank, Nedbank and Capitec. This in turn, influences the prime rate, which is the interest rate banks use when they are granting loans to consumers. The prime rate is usually 3 to 3.5 percentage points higher than the repo rate.

Consumer price index: is an index that is calculated monthly by Stats SA and measures the change in cost of a representative basket of goods and services such as food, energy, housing, clothing, transportation, medical care, entertainment and education. Inflation is typically expressed as the percentage change of this index over 12 months.

When talking about your investment portfolio:

Diversification: is the age-old practice of not having all your eggs in one basket. Spreading investments to limit exposure to any one type of asset class and sector, helps reduce the volatility, and risk, of your investment portfolio over time. To create smooth inflation-beating returns, you need a mix of sectors and companies in your portfolio so that when some investments perform badly, this can be offset by strong performance elsewhere. For example, when interest rates are low and consumer confidence is high, the retail sector typically does well. When the rand is weak, retailers suffer by paying more for imported goods while the mining sector could do better as exports are cheaper for international buyers.

Compound interest: Compounding is the reason investing works over the long term. Over time, you earn returns on reinvested money or interest on interest. Saving R10 000 at a return of 6% and withdrawing the interest every year means at the end of 10 years, you will still  have R10 000, with R600 each year in returns (or R6 000). However, if you chose to reinvest the returns, you would be generating returns on R10 600 by year two; generating returns on R11 236 in year three, and so on. You would be earning more interest each year because the amount invested each year is increasing, without you having to make any additional investment contributions.

Asset allocation: refers to the process of splitting an investment so that there is investment in one or a combination of all of the four asset classes -  equities, bonds, cash and property. The constant asset allocation adjustments, to implement short-term optimal asset allocation, are referred to as dynamic asset allocation.

Cash: This asset class is a little more than the everyday man’s perception that it simply refers to keeping your money in the bank. Cash is widely considered to be the safest asset class but the flip side is that it generally provides the lowest return over the long-term. It includes investments such as on-call deposits in banks, and similar short-term, interest-bearing investments.

Volatility: refers to the amount of uncertainty or risk. Volatile markets are ones where investment values could move vigorously and unpredictably. A higher volatility means that the price of an investment can change dramatically over a short time period in either direction. A lower volatility means that the investment’s value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.  Over the long term, investors that are willing to take on higher volatility over the short term, should be rewarded by higher returns from these type of investments.  

When fund managers are explaining why they selected specific stocks within a fund:

PE ratio: Price earnings ratio. Often used by fund managers when they are analysing a stock, this refers to the relationship between the company’s share price and the earnings per share. It is popularly used to determine the value of the share. The company’s PE ratio helps fund managers determine how much a company’s current share price is worth in relation to current or future earnings. Companies with a low PE ratio could typically be considered cheap and therefore can provide significant upside return potential as the share price recovers from its lows.  On the other hand, companies with a high PE could be considered expensive and the share price might already reflect the market’s expectations of strong future growth prospects for the company.

Earnings revision: This is an investment style used by Discovery fund managers in our flagship range of Balanced Funds. The fund manager chooses to invest in companies that are trading at reasonable valuations where expected future earnings are being revised upwards.  Earnings revisions is a strong sentiment indicator.  An improvement in the outlook for a company is typically reflected in the market’s earnings expectations for the company being revised higher.  The share prices of companies which are receiving positive earnings revisions typically outperform, whereas those companies where the outlook is deteriorating could see earnings estimates being revised lower by the market.

Sources: www.corporatefinanceinstitute.com; South African Reserve Bank; South African Savings Institute; www.investopedia.com; Investec Asset Management

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^{This article is meant for information purposes only and should not be taken as financial advice. For tailored financial advice, please contact your financial adviser.}

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