Fundamentals of investing
Capital markets offer a wide range of options for you to invest money and build wealth.
See the following page to learn the basics of how capital markets work and what institutions are important for the functioning of the capital market in Austria: Important institutions in the financial market
Investing: How can I invest my money?
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Example
Alina has been working as a construction site coordinator at a large construction company for three years. She has saved enough money to invest some of it. This raises the fundamental question of why it makes sense for her to invest her money.
Alina could leave her savings in a current account or simply put it in a savings account. These types of investment are low-risk and Alina can access her money quickly when she needs it. However, these types of investment usually have low returns. This means that the interest rate that Alina gets for her savings is low, regardless of whether the money is in a current account, a savings account or a savings book. If you want your savings to grow, you should consider various other types of investment. Shares, bonds and funds usually generate higher returns on capital invested. However, this also means that these types of investment are associated with higher risk. It is therefore crucially important that you do your research before investing your money.
Assessing investment risks
Investors seek to seize opportunities. People who put their money in securities want to invest their money wisely, i.e. to make a profit, or to invest their money in something they believe in or want to support.
Opportunities usually come with risks. Therefore, investing in securities always involves certain risks. It is important that investors understand these risks and adapt their investment strategy accordingly. Using certain strategies, you can manage risk and reduce the probability of losing some of the money you have invested.
It is a fundamental principle of investing that there is a direct link between risk and return. As a rule, investors that are prepared to take greater risk can make higher returns. The opposite is also true: higher potential returns mean a higher probability of incurring losses.
To reduce their risk, many investors use Diversification. Diversification means that investments are spread across a number of asset classes (types of securities and assets), sectors and/or regions that are, to the greatest extent possible, unrelated to one another. The idea is that largely unrelated, or uncorrelated, asset classes respond in different ways to economic events and market movements. For this reason, a broadly diversified portfolio can reduce overall risk.
If we knew exactly how companies would do in the future, we would not need any diversification strategies, and we could invest in exactly those shares that we know will go up in price. However, we do not know how companies or sectors and regions will do in the global economy. Therefore, it makes sense for investors to combine a number of different types of investment with different risk and return profiles.
Diversification strategies
There are various methods to reduce investment risk. You can minimize risk both within an asset class and by combining different asset classes. Diversification strategies aim to identify a combination of assets that, given a set of market conditions, respond in different ways in terms of potential returns and risk of loss.
Shares
Within this asset class, you can minimize your risk by buying shares in companies from different sectors and industries, purchasing shares in both large and small companies, and combining shares in companies with maximum geographical diversification.
Bonds
Within this asset class, you can reduce the default risk by investing in bonds issued by solid debtors such as governments and large companies with a strong credit rating. Note that higher-yielding bonds usually have a higher default risk. In addition, you can reduce interest rate risk by investing in bonds with different maturities.
Asset classes
Across asset classes, you can reduce risk by investing in a combination of shares, bonds and other lower-risk investments. By supplementing your portfolio with low-risk assets such as gold and overnight deposits, you can minimize risk, especially during times of crisis.
Sustainable investing
Sustainable investing means investing in companies and projects that take social, environmental and ethical considerations into account. These companies and projects do not only seek financial returns but aim to have a positive impact on the environment and society as well. It is important to note that it is possible to achieve high returns despite – or precisely because of – the positive impact on the environment and society. Examples include renewable energy companies. Many of these companies have had a positive impact on the environment in recent years and achieved high returns at the same time.
There are various types of sustainable investment products, such as green bonds, ethical investment funds and sustainable stock indexes. These products are often assessed on the basis of ESG criteria, which rate environmental, social and governance performance. Exclusion criteria help to rule out companies that violate certain ethical standards. Labels and certifications can also help investors recognize sustainable products. In Austria, for example, these include the Austrian Ecolabel for Sustainable Financial Products (UZ 49) and the FNG-Siegel, a quality standard for sustainable investments in German-speaking countries.
Sustainable investing is a growing trend in the financial industry, driven in part by increasing demand for sustainable financial products and increasingly stringent legislation. In 2018, the EU created an action plan on sustainable finance that includes the Taxonomy Regulation and the Sustainable Finance Disclosure Regulation. See here for more information.
Types of risks
The figure below shows potential risks associated with investing: Every investment has its own risk profile, and not all risks are created equal for all investments.
Market risk is risk stemming from overall market performance. There is a likelihood that the overall market or a specific market sector does not perform as expected. One well-known example is the 2008 financial crisis. During the financial crisis, the prices of many shares around the world plummeted. People who invested in shares before the crisis saw the value of their portfolios fall sharply as (most) shares plunged in value. A general loss of confidence in financial markets led to a broad decline in share prices, irrespective of individual company performance.
Default risk in bonds refers to the probability that the issuer of the bond will not be able to meet its payment obligations (principal and interest). This risk could materialize due to sales problems, financial difficulties, a deterioration in creditworthiness and macroeconomic factors.
Price risk is the risk that an asset price will fall. During the COVID-19 pandemic, repeated production halts and supply chain disruptions led to shortages of certain products. These unexpected declines in production meant that customer demand could not be met. As a result, these companies saw their revenues plunge, and their reputation also took a hit. Share prices fell, resulting in losses for investors. Pharmaceutical companies and tech companies, by contrast, benefited from the pandemic, and their share prices rose during the crisis.
Liquidity risk arises because it is not or not always possible to quickly sell certain securities or assets at an adequate price and thus convert them into money. For example, investors wishing to sell shares with low trading volumes might struggle to find a buyer.
Interest rate risk is caused by potential changes in Interest rates. Rising interest rates make low-risk fixed-interest assets, such as bonds, more attractive because their return increases while their risk remains low. By contrast, riskier assets, such as shares, become less attractive. Demand for shares goes down, leading to a decline in prices. In addition, higher interest rates mean lower profits for companies because their borrowing costs go up. This can also drive down share prices. When interest rates are falling, investors are more willing to put their money in riskier assets with higher potential returns. Demand for shares goes up, pushing up share prices. In addition, companies benefit from lower borrowing costs, which means higher profits that can also led to higher share prices.
Currency risk comes from potential changes in exchange rates that can affect investments made in foreign currencies. When a foreign currency depreciates against the euro, this can reduce the value of investments denominated in that currency.
Company-specific risk is risk that applies to the investment in a particular company. For example, a company can get into trouble due to management problems and legal issues. If investors lose confidence in the company’s future performance and sell their shares, the share price will go down.
Inflation risk is the risk that inflation erodes the real value of an investment as high inflation rates reduce the purchasing power of the money invested.
On top of the risks described above, assets might be affected by political and geopolitical risks. They are due to uncertainty arising from political decisions, instability and conflict between countries. These developments are difficult to predict and can therefore cause market volatility, affect trade relations and have a direct impact on the profitability of investments.
Climate and environmental risks can be divided into physical and transition risks. Physical risks relate to the direct consequences of climate change, such as extreme weather events, flooding and mudslides.
Transition risks are risks that companies face due to the transition to a climate-neutral economy and society.
Climate risks are not isolated and have an impact on other risk categories. For example, the physical risk of an extreme weather event can reduce the value of real estate (default risk).
Transition risks include political and legal changes such as the introduction of a carbon tax and changes to building regulations (political risks). Other transition risks relate to technological change, such as the expansion of renewable energy and changes in consumer behavior (market risk).
An exchange is a market where securities such as Shares,Bonds, commodities and currencies are traded. The main role of an exchange is to bring together investors and companies that need capital to expand their business. Well-functioning markets (exchanges) make it easier for companies to raise capital to achieve their goals, such as investing in new technologies, developing new products and creating jobs.
Exchanges are crucial to capital markets as they offer a trading platform, monitor trading, admit new companies to trading and are a source of key market information.
Some of the most prominent exchanges are the US-based New York Stock Exchange (NYSE) and the NASDAQ. In Austria, the largest securities exchange is the Vienna Stock Exchange. Website of the Vienna Stock Exchange
Exchange trading is subject to strict legal regulations that ensure an orderly process allowing market participants to buy and sell securities such as shares, bonds and other financial instruments. Like other markets, exchange trading is based on the fundamental principle of supply and demand. When many buyers want to purchase a security and there is not a lot of supply, the price of that security will go up. Conversely, if there are few buyers willing to purchase a security and many market participants want to sell, the price of the security will go down.
Example
Shares in Sonnenschein AG, a listed company, trade at a price of EUR 50 a share. In April, the company reports strong quarterly earnings and an increase in demand for renewable energy and announces innovations that improve its photovoltaic technology. This positive news attracts investor interest, leading to strong demand for Sonnenschein AG shares. The share price rises because many investors are looking to invest in the company, and supply is limited. Within a short time of time, the share price rises to EUR 60.
At the end of the year, Sonnenschein AG announces that a disruption in the supply of key components has brought production to a complete standstill. Investors lose interest in the company and sell shares in Sonnenschein AG, while buyers are few and far between. As a result, the share price goes down.
Share price movements (up and down) can be caused by a variety of very different reasons. In addition to company performance, political events and decisions, tax policy and inflation can have a strong impact. When investing in securities, it is therefore important to follow political and economic developments, both nationally and internationally.
How to buy securities
To buy securities, investors place an order on an exchange. There are various types of orders:
Example Market Order
Market orders are unlimited buy or sell orders. This means that the orders will be executed as soon as possible at the current share price.
If Ms. Humpel wants to buy 100 shares of Sonnenschein AG as soon as possible, she can place a market order. Ms. Humpel’s broker will buy 100 shares at the current price of EUR 60.
Example Limit Order
Limit orders are orders to buy or sell securities at a specific price or better.
If Mr. Jurkovic wants to sell 100 shares of Sonnenschein AG at a price of EUR 65, even though the current price is EUR 60, he can place a limit order. As the share price is EUR 60 and Mr. Jurkovic is looking to sell at minimum price of EUR 65, the order will be placed in an order book. It will not be executed until the share price has risen to EUR 65. Limit orders expire at a specified date. They can expire at the end of the day, the end of the month or on another date in the future.
Market orders and limit orders are the two most common order types. For more order types , see the website of the Vienna Stock Exchange website: Retail investors should always place limit orders to avoid a situation where orders are executed at an unfavorable price.
Using indexes as a point of reference
An index is a single number representing the price of the assets that constitute the index components. Indexes show changes compared to previous index prices, for example in stock and bond markets. The changes are often represented in the form of a chart.
Indexes serve as benchmarks tracking the overall performance of stock markets, allowing investors to see whether their own investments outperformed or underperformed the index. The ATX (Austrian Traded Index), for example, provides important information on the performance of Austrian markets. It tracks the performance of the 20 largest companies on the Vienna Stock Exchange and can be accessed through this link.
Taxes on investment income
Austria levies investment income tax (KESt) on investment income such as interest income and capital gains (for example on shares, bonds and shares in funds). It is a form of income tax and taxes all investment income at a rate of 27.5% (as of 2024, except for interest on savings accounts and current account balances, which are taxed at a rate of 25%). In the case of domestic investments, it takes the form of a withholding tax. This means that investment income tax is withheld by the bank or broker, which transfer the amount owed to the tax office. Before opening a Custody account (or securities account/brokerage account), investors should therefore inquire whether their bank or investment service provider is based in Austria and pays investment income tax (KESt) directly to the tax office. If this is not the case, investors have to declare the income in their Employee tax assessment or Income tax return and pay the tax owed by themselves.
A brief recap
How is risk related to return?
It is a fundamental principle of investing that there is a direct correlation between risk and return. As a rule, the more risk an investor is prepared to take, the higher their potential profit. Conversely, however, this also means: The higher the potential profit, the higher the probability of making a loss.
How can you minimize your risk?
In order to reduce investment risks, many investors use Diversification as an investment strategy. Diversification means that investments are spread across a number of asset classes (types of securities and assets), sectors and/or regions that are, to the greatest extent possible, unrelated to one another.
What criteria should you apply in making sustainable investments?
Sustainable investing is an approach that considers environmental and social aspects in addition to financial returns. Criteria such as the environmental impact, social responsibility and good corporate governance (ESG criteria) play a central role in this regard. In addition, you can define Exclusion criteria when selecting your securities. For example, you can decide to exclude child labor and the arms industry.
What do you need to consider regarding the taxation of investment income?
Austria levies investment income tax (KESt) on investment income, e.g. capital gains (for example on shares, bonds and shares in funds). It is a form of income tax and taxes all investment income at a rate of 27.5% (as of 2024, except for interest on savings accounts and current account balances, which are taxed at a rate of 25%).