How the investment world works

A scroll through the investment world.

Back to basics

It is easy to get lost in the investment world. The noise and jargon can be overwhelming.

Let’s take a step back and look at the basics to help you understand how it all works.

Investor

Every investor is different and there are a variety of ways to invest. Here we will look at one of the most basic ways to invest: buying shares.

Company

Companies need money from investors to grow their business. There are two main ways how they do this: borrow money (bonds) or offer ownership in the business (shares).

How to buy shares

Let’s assume that the investor wants to buy some shares in a company that is listed on the New Zealand Stock Exchange (NZX).

The investor cannot trade directly on the stock exchange. In order to transact on the stock exchange, the investor needs to use a broker.

Broker

The broker is a party that can transact on the stock exchange. They work with investors that want to buy and sell shares. Their primary task is to connect buyers with sellers.

They are generally compensated for their service by charging a fee on each trade and/or by squeezing out a margin between the buyers and sellers.

Which company should an investor buy?

Globally, there are thousands of companies to invest in. Therefore, finding the best individual companies is a huge task. To help with this it can be worthwhile to consider appointing a fund manager.

Fund Manager

Rather than buying shares themselves, the investor can let a fund manager pick the companies. A fund manager will typically charge the investor a percentage fee on the invested money for selecting the shares.

Which manager should an investor choose?

There are hundreds of different fund managers around the world. How should the investor know which manager is good and suits their needs? That is where an adviser can help.

Adviser

The adviser helps the investor navigate the investment world. This typically involves providing recommendations on fund managers, as well as on the split between bonds and shares.

Advisers will charge fees for their services as either a percentage of the invested money or as a fixed dollar amount.

The one that people do not often talk about

One lesser-known party should always be involved to safeguard your money, a custodian.

Custodian

The custodian protects investments from being lost or stolen. A bit like a bank, they hold investments on behalf of the investor. A custodian will generally charge a percentage fee to keep the investments safe and secure.

The Tasks

We can summarise the tasks in the investment world as follows:

Advise ⇒ give recommendations
Transact ⇒ trade shares
Manage ⇒ select shares
Protect ⇒ safeguard the shares

WARNING

When one party undertakes more than one of the four tasks, there is usually a conflict of interest that you need to understand and question.

It may not be obvious at first, but it could limit the quality of the service or increase the risks and costs of a task.

The way it is often done

There are two common approaches to navigating the investment world.

1. Do it yourself

The investor picks the companies without any help. However, this approach still requires a broker to transact and there should be a custodian involved to protect the investments.

2. Best-in-class

We consider using an independent party for each of the four tasks to be the best-practice approach.

This is how most large investors typically navigate the investment world. Each party has one core task and can concentrate on their speciality.

Approach

The adviser should recommend appropriate fund managers to select the shares. The fund manager selects the shares and goes via a broker to transact. The fund manager should also have a custodian to protect the investments.

There are lots of other ways of how people invest, but we hope this simple overview is helpful.

Makao Investments is an adviser. We help our clients navigate the investment world. We advise them on a suitable investment strategy and help them find appropriate fund managers.

Back to basics

It is easy to get lost in the investment world. The noise and jargon can be overwhelming.

Let’s take a step back and look at the basics to help you understand how it all works.

Investor

Every investor is different and there are a variety of ways to invest. Here we will look at one of the most basic ways to invest: buying shares.

Company

Companies need money from investors to grow their business. There are two main ways how they do this: borrow money (bonds) or offer ownership in the business (shares).

How to buy shares

Let’s assume that the investor wants to buy some shares in a company that is listed on the New Zealand Stock Exchange (NZX).

The investor cannot trade directly on the stock exchange. In order to transact on the stock exchange, the investor needs to use a broker.

Broker

The broker is a party that can transact on the stock exchange. They work with investors that want to buy and sell shares. Their primary task is to connect buyers with sellers.

They are generally compensated for their service by charging a fee on each trade and/or by squeezing out a margin between the buyers and sellers.

Which company should an investor buy?

Globally, there are thousands of companies to invest in. Therefore, finding the best individual companies is a huge task. To help with this it can be worthwhile to consider appointing a fund manager.

Fund Manager

Rather than buying shares themselves, an investor can let a fund manager pick the companies. A fund manager will typically charge the investor a percentage fee on the invested money for selecting the shares.

Which manager should an investor choose?

There are hundreds of different fund managers around the world. How should the investor know which manager is good and suits their needs? That is where an adviser can help.

Adviser

The adviser helps the investor navigate the investment world. This typically involves providing recommendations on fund managers, as well as on the split between bonds and shares.

Advisers will charge fees for their services as either a percentage of the invested money or as a fixed dollar amount.

The one that people do not often talk about

One lesser-known party should always be involved to safeguard your money, a custodian.

Custodian

The custodian protects investments from being lost or stolen. A bit like a bank, they hold investments on behalf of the investor. A custodian will generally charge a percentage fee to keep the investments safe and secure.

The Tasks

We can summarise the tasks in the investment world as follows:

Advise ⇒ give recommendations

Transact ⇒ trade shares

Manage ⇒ select shares

Protect ⇒ safeguard the shares

WARNING

When one party undertakes more than one of the four tasks, there is usually a conflict of interest that you need to understand and question.

It may not be obvious at first, but it could limit the quality of the service or increase the risks and costs of a task.

The way it is often done

There are two common approaches to navigating the investment world.

1. Do it yourself

The investor picks the companies without any help. However, this approach still requires a broker to transact and there should be a custodian involved to protect the investments.

2. Best-in-class

We consider using an independent party for each of the four tasks to be the best-practice approach.

This is how most large investors typically navigate the investment world. Each party has one core task and can concentrate on their speciality.

Approach

The adviser should recommend appropriate fund managers to select the shares. The fund manager selects the shares and goes via a broker to transact. The fund manager should also have a custodian to protect the investments.

There are lots of other ways of how people invest, but we hope this simple overview is helpful.

Makao Investments is an adviser. We help our clients navigate the investment world. We advise them on a suitable investment strategy and help them find appropriate fund managers.