What it means
When you buy an investment product you are giving up money today in exchange for a claim on future income, growth or both. A bond pays regular interest, a share may pay dividends and rise in price, and a deposit pays interest at a stated rate.
The return you actually receive depends on the product, the market and the time you hold it. Products differ along a few key lines.
Risk is the chance that the value falls or that the return is lower than expected, and liquidity is how quickly the product can be turned into cash without a big loss. A listed share is far more liquid than a stake in a private company, and cost covers the fees and charges that reduce your return.
Products can also be packaged. A mutual fund or exchange-traded fund pools money from many investors and spreads it over many holdings, which provides diversification (spreading money across different holdings to reduce the damage if one fails).
Structured products and insurance-based products add layers, such as guarantees, which usually come with extra fees. In business, finance teams choose investment products when they hold surplus cash, fund pensions or build reserves.
They usually write down an investment policy that says which products are allowed, how much can sit in each and what credit quality is needed. Matching the product to the purpose is the key principle: money needed next month should not sit in a volatile share fund.
Because cost is certain and returns are not, fees deserve close attention. A product that charges 1.5% a year needs to earn far more than one that charges 0.1% just to leave the investor in the same position.
Finally, products carry different tax treatment, and the same pre-tax return can leave you with very different amounts after tax. Interest, dividends and capital gains are often taxed at different rates, and some products sit inside tax-advantaged wrappers.
A sensible comparison always looks at the return after both costs and tax.
In practice
Real-world examples.
Example
A software company has $3,000,000 of cash it will not need for 12 months. The treasurer places it in a money market fund and short-term deposits because they are safe and easy to cash in. She rejects a share fund, as a market fall could leave too little to meet payroll.
Example
A couple in their thirties invest $500 a month into a low-cost index fund held inside a retirement account. The product matches their long horizon, and they can tolerate ups and downs in value.
Example
A retiree buys an annuity that pays a fixed monthly income for life. The product gives certainty of income, but it is hard to reverse, so he keeps part of his savings in cash for emergencies.
Formula
Calculation
Annual cost of a product = amount invested x total annual charge percentage
A company invests $100,000 in a managed fund that charges a total of 0.75% a year. The annual cost is 100,000 x 0.0075 = $750. If the fund earns a gross return of 6%, the gross gain is 100,000 x 0.06 = $6,000, and the net gain after charges is 6,000 - 750 = $5,250, a net return of 5.25%.Case study
Seen in the real world.
Greywell Logistics is an illustrative, fictional company with a $2,000,000 reserve earmarked for replacing its trucks in about two years. Seeking higher returns, a junior analyst proposed moving the entire reserve into a share-based fund.
The finance director pointed out that the money had a fixed date of use, and that a 20% fall in markets would leave the company $400,000 short. The board agreed to split the reserve: $1,200,000 in government bonds maturing in time, $600,000 in a bond fund and $200,000 in shares.
The illustrative lesson is that the right investment product depends on when the money is needed, not only on which product has the highest expected return.
Watch out
Common mistakes.
- Choosing a product by its past return alone, when past performance does not predict the future and risk differs widely.
- Ignoring fees, when a small annual charge compounds into a large cost over many years.
- Assuming that a complex product must be better, when added features often add costs and make the product harder to understand and sell.
Questions
People also ask.
What is the difference between an investment product and a savings product?
A savings product, such as a deposit, mainly protects the amount you put in, while an investment product accepts the chance of loss in return for higher expected growth.
How do I decide which product is right?
Start with the purpose, the time horizon and your tolerance for risk, then compare costs and how easily you can cash in.
Do all products have a regulator?
Most are regulated, but the rules differ by product and country, so check who oversees both the product and the firm selling it.
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