Key Investment Terms & Overview of Risks

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What is inflation?

Inflation is the process by which your money declines in value over time. This loss of money doesn’t show up in your bank account — but rather as loss in ‘purchasing power’. For example, in 1970 a cup of coffee could be purchased for €0.25. But today, you need to pay at least €1.59. Economists measure this loss of value as a percentage. In most developed economies, inflation is at 2% per year. This may sound like a small number, but this can have a big impact on your financial health over the long-term. If, for example, you keep €100,000 in your savings account for 14 years, it will have lost a quarter of its value — and be worth only €75k.

Currently, interest rates in Europe are at an all time low (0.32%) and they’re not predicted to rise meaningfully anytime soon. Therefore you cannot earn a sufficient interest rate to outstrip inflation when leaving your money on your savings account. This makes investing even more important and paramount for your long-term financial future.

What is diversification?

“Diversification” is the financial industry’s version of “don’t put all your eggs in one basket”. Diversification is very important because it protects you from various risks and creates long-term stability for your returns. Your investment is diversified if you invest in different asset classes, such as real estate, stocks, bonds etc. Choosing different asset classes is important because each tend to behave differently. In some market situations, one class may rise in price, while another may drop. By not betting on one single asset class, your portfolio is much more likely to provide stable returns, and protect you from market crashes.

What is an ETF?

Think of an ETF as a big basket, filled with different investments. Inside can be stocks, bonds, commodities, etc. The ETF is ‘trying’ to represent a certain market, industry or strategy. “UBS MSCI Europe”, for example, is an ETF which holds 434 of the largest European companies. And if you invest €1000 in this ETF, your money will be spread across all 434 companies inside the ETF. The great thing about ETFs is that it’s a very easy way to diversify your money — with just a few clicks.

In technical terms, ETF stands for Exchange Traded Fund, so it’s a fund that can be bought and sold directly on stock exchanges. This gives them more flexibility and a bigger size than a lot of traditional funds. Furthermore, ETFs track an index, i.e. mirror a market. This means there’s no fund manager deciding what comes in and out. This makes ETFs a passive and highly automated investment, which in turn lowers their price significantly. Further evidence has consistently shown that this creates better long-term returns than active human judgement, which is often prone to biases.

In the last two decades ETFs have become the most popular way for investors to cheaply create and diversify their portfolios, for example Sweden’s pension system is built on them and they have outcompeted most actively managed funds in terms of performance.

So in short ETFs are traded directly on stock exchanges and they usually represent a major market by replicating it. This makes ETFs diversified, cheap and flexible.

What does a financial advisor do?

A financial advisor helps their clients make sound investment decisions. Sagefund (as a tied agent of Bank für Vermögen) acts as your financial advisor. Our primary goal is to ensure our users build up wealth long-term. We do this by recommending suitable investment products (such as “Sagefund Stability”) to our users. Here, we consider several important variables, such as your personal financial situation, performance of the investment, price, and of course sustainability. In order to determine the quality of our investments we conduct a lot of research - such as looking at historical and present evidence, comparing different ETFs and how they worlk together, as well as running simulations.

What is Volatility?

Volatility is an important indicator for risk. It represents how much the value of an investment changes in price (swings up and down). More speculative investments have greater price swings, while safer investments typically have much smaller price swings. Knowing how steep the changes in price are, can help you determine the length of your investment horizon. Volatile assets are often considered riskier than less volatile assets because the price is expected to be less predictable.

What basic asset classes do we invest in?

• Stocks: A stock is a tiny piece of a company. As soon as you buy a stock, you co-own the company. Stocks are traded on the stock exchange. As a company grows (through innovation or efficiency increases) its price grows as well. Stocks are the primary driver of growth in a portfolio
• Bonds: When you buy a bond, you are essentially loaning money to an organization, so it can fund a specific project. For example the German Government issues bonds to renovate schools and build infrastructure. In exchange for the loan, the organization promises to pay you back plus a fixed interest rate. Because of this, bonds are quite stable investments.
• Commodities: Commodities are typically raw materials, such as gold, gas or soybeans. Our portfolios contain sustainable commodities like clean energy and timber. Commodities are important because they behave differently from stocks and bonds — this is good for diversification.
• Real Estate: Real estate is the land along with any permanent improvements attached to the land, such as buildings (offices, malls etc.) and residential homes. Real estate is a great protection against inflation and is more predictable in performance.

Overview of Risks

Here we look at a list list of some of the biggest risks to consider when purchasing an investment portfolio. Each of these risks, if they occur, can cause dramatic changes in the value of your investment. However, it’s worth noting that your gains and losses are only realised at the moment you sell your investment.

Cyclical risk: Cyclical risks exist because the broad economy moves in cycles — periods of high growth (peak), followed by a downturn, then a trough of low activity. Between the peak and trough of a business or economic cycle, investments can fall in value significantly, reflecting lower profits and the uncertainty surrounding future returns. This risk is best managed by diversification, long-time horizons and enough financial buffers to weather downturns. Further downturns can be an opportunity to buy investments for a much cheaper price, think of it as a possible sale’s opportunity.

Currency risk: At Sagefund we invest in a global portfolio, this means you will be exposed to foreign currencies such as British Pounds and US Dollar. Currency prices are subject to gains and losses, so by holding foreign currencies there’s the possibility of losing money due to unfavourable moves in exchange rates.

Interest Rate risk: The potential that a change in overall interest rates will reduce the value of a bond or other fixed-rate investment.

Termination risk (bonds): The debtor of a bond can reserve the right to early termination. Bonds are often given such a right of termination in periods of high interest rates. If the market interest rate falls, the risk increases for you as an investor that the issuer will exercise its right of termination

Liquidity risk: Liquidity risk stems from the lack of marketability of an investment that can’t be bought or sold quickly enough to prevent or minimize a loss. It is typically reflected in unusually wide bid-ask spreads or large price movements.

Country risk: Refers to the uncertainty inherent with investing within a given country. This uncertainty can come from any number of factors including political and economic ones. Country risk most often refers to the possibility of the inability to pay back debts.

Credit Risk: Credit risk is the possibility of a loss resulting from a borrower’s failure to repay a loan or meet contractual obligations. Traditionally, it refers to the risk that a lender may not receive the owed principal and interest, which results in an interruption of cash flows and increased costs for collection.

Default risk: The risk that a lender takes on in the chance that a borrower won’t be able to make required debt payments. A free cash flow figure that is near zero or negative could indicate a higher default risk. Rating agencies break down credit ratings for corporations and debt into either investment grade or non-investment grade.

Counterparty risk: The likelihood or probability that one of those involved in a transaction might default on its contractual obligation. Counterparty risk can exist in credit, investment, and trading transactions.

Total loss risk: The risk that you can lose your entire invested amount. In a globally and properly diversified portfolio this means, that things would have to go terribly wrong all at the same time (think of possible advent of WW3 or the total environmental collapse of our global civilisation) and as a consequence you lose all the money you invested.