Basic Investment Concepts

Diversification
Diversification is sometimes called the only free lunch in finance. It involves investing in various types of investments across asset classes, industries, sub-segments and geographies. The basic premise is that if you have a variety of investments, the risk of the portfolio is greatly reduced, as your dependence on one such investment is reduced. This reduction in risk does not equate to a reduction in return (as you would think) as the mix of investments in your portfolio move to effectively offset each other.

Portfolio
A portfolio is a number of shares. Two shares can form a portfolio. Portfolios reduce the risk of your investments as they are diversified.

Indexes
Indexes effectively group shares into categories. The most common index in Australia is the All Ordinaries Index which is a summary measure, weighted according to the market capitalisation of the companies. It also reflects the current trends in the market and provides a good benchmark or indicator of share market reactions to economic events. This is the number that is reported on the news to indicate the general trend of the market. The ASX200 is also another commonly quoted index which lists the top 200 shares on the ASX. There are also other indexes for specific industries and segments, for example the Industrials, Healthcare, Consumer Staples, Information Technology, Metals and Mining and many others.

Dividends
Once a company makes a profit, the profit must be spent, after paying all the expenses of running the business. This is commonly spent on either a dividend which is in the form of a cash payment to shareholders, reinvesting in the business, or in a share buyback, which increases the share price. There are different reasons and effects of all three methods of distributing profits; however dividends are a form of rewarding the customer for their investment. In addition, dividends also provide the investor with a franking credit (or imputation credit), which means that tax on these earnings have been paid and are an additional credit to the investor.

Bonds
When an organisation requires funds, it can issue a bond which is a type of ‘debt security’ (meaning it is a form of debt in accounting terms). Investors pay for this bond by giving the organisation money, and in return, the organisation must repay the principal and interest (also called the coupon) at a later date. Bonds are generally issued for a fixed term but are long term (more than 10 years). In US terminology, a bill is less than one year, a note is between one and ten years and a bonds maturity is beyond 10 years.

Private Equity
This is a broad term which refers to an equity investment in assets that are not freely tradeable on the public stock market. This is the raising of funds via private markets, as opposed to public markets. Although Private equity firms invest in assets which were not in the public market they also invest in companies listed on public exchanges and take them private. Companies such as KKR and CCMP are the largest Private Equity companies targeting Australian companies.

Categories of private equity investment include leveraged buyout, venture capital, growth capital, angel investing, mezzanine capital and others. Private equity funds typically control management of the companies in which they invest, and often bring in new management teams that focus on making the company more valuable

As they are not listed on an exchange, a private equity firm owning such securities must find a buyer in the absence of a traditional marketplace such as a stock exchange. The "exit" or "selling out" is often achieved by way of an initial public offering (IPO), i.e. floating the company on a stock exchange, trade sale or secondary/tertiary buy-outs (i.e. sale to another private equity house)

Annual reports
Annual reports provide an investor with detailed financial information, in addition to major activities over the course of the financial year. This report is used as the basis for all value investors, which uses the numbers to deduce how the company is performing. The format of the report is outlined in the ASX listing requirements, and provides sufficient information for investors to establish how their investments are going. These reports aren’t restricted to the shareholders and are available in the public domain. These Annual Reports are usually presented at the Annual General Meeting (AGM) where all shareholders are invited to attend a presentation from the Board of Directors and company Executives of how the company has performed and are allowed to ask questions. Usually, the Chairman will give a run down of what the company is expecting in the upcoming 12 months, which is another bit of important information which can prove handy in establishing an investors future investment decisions.

Capital gain
The Capital gain is the difference between the purchase price and sale price, assuming there is a profit. There are no capital gains if you do not close out your position (if you do not sell). This capital gain attracts tax at your margin rate, which is called the capital gains tax. If you own the share for more than 12 months, tax is paid on half the gain, which is further incentive to keep shares longer than 12 months.

Capital losses
Capital losses are the opposite of capital gains, in that you make a loss on the buy and sell trade. This loss can be used to offset against capital gains in the same year. Or, if you do not have any capital gains in that year (you may not have realised your gain), the Australia Taxation Office allow you to carry them to the next year, until all used.

To calculate Capital Gains/Losses

Total Proceeds minus Total Costs (from the contract notes)
If negative, this is a loss, if positive, this is a gain
if you have held these for more than one year and it is a gain, add half of the gain to your taxable income.
If you have held them for less than one year and it is a gain, add the total gain to your taxable income
If it is a loss, this can be applied to the gains from share trading throughout the year.