Know your jargon, but watch you don’t hit the wall

concerns. I am as guilty as others of using words such as defensive, diversified, conservative and undervalued to help investors overcome their nervousness around investing.

Unlike ‘‘86 the garden’’, it is worth taking the time to understand the fundamental basis behind investment jargon, because it can often be misused and misunderstood, to the cost of investors.

One concept is defensive investing which refers to buying investments that hold up well during times of financial turmoil. The textbook examples of defensive businesses have always been cereal companies and newspapers, because we all eat breakfast and read the news, even in a recession.

Defensive characteristics can disappear though – these days far more people read their news online than those who devour the paper along with their Weet-Bix. Also, investment returns depend largely on the price that investors pay, and defensive companies can get expensive when markets are nervous. A defensive investment could prove anything but defensive if you overpay from the start.

Another concept is correlation, which is a statistical measure of how two assets trade relative to each other. The idea is to find stocks that are only loosely correlated with each other, so that one will continue to do well even if others fall. Correlation worked a treat until the market meltdown in 2008 where all risky assets fell in unison, regardless of how they had behaved previously.

Beta is a slightly harder concept to grasp. It is used as a measure of a stock’s risk. The beta describes how volatile a stock has been relative to a benchmark like the NZX50 Index. For example, SkyCity has a beta around 1, meaning it is as volatile as the market, while Air New Zealand with a beta of 1.3 has been more volatile and Kiwi Income Property Trust at 0.8 has been less.

The theory is that high beta stocks perform best over time while low beta stocks should provide a less volatile, somewhat safer option. However, using a US example, Apple has a beta of 1.2 and prospered throughout the GFC whereas Netflix with a beta of 0.7 struggled to hold its own.

Understanding the meaning of financial jargon is a must for any serious investor. While many of the words and phrases have been developed to explain the many unpredictable aspects of financial markets, and provide comfort to investors, they should not be relied on in decision-making.

There is no shortcut to finding the best stocks, and however impressive the jargon sounds, it will never be a good excuse for having invested in the wrong thing. Carmel Fisher is managing director of Fisher funds, an investment manager and KiwiSaver provider.