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Guide to investing

Investing is a personal issue and individual needs vary greatly. Any investment decision should be based on rational and logical reasoning as to what you need and hope to achieve.

Determine your investment objectives

The first thing you should do before making an investment is to determine your investment objectives. To determine this, ask yourself the following questions:

  • How much money do I have available to invest?
  • What do I want to achieve from the investment?
  • Over what period?
  • What risks am I prepared to take to achieve this?
  • What rate of return do I require from the investment?
  • What other investments do I have that should be considered as part of my overall strategy?

Risk and returns

The balance between investment risk and investment return is particularly important. Your risk/return profile needs to be determined, in conjunction with your adviser, to determine an appropriate investment strategy that meets your objectives.

Risk

Risk is the chance that the return from an investment will be significantly different from what you expected. There is an element of risk in every type of investment and it can show up in various ways:

  • There is a risk that you may not get the earnings (or return) you expected from your investment
  • There is a risk that you may lose some or all of your capital
  • There is a risk that changes in the value of money, due to inflation, mean that you are not compensated adequately for your investment

It is important to determine the degree of risk which is acceptable to you and have your adviser match it with appropriate types of investments.

Return

Some investments promise a fixed rate of return (such as fixed interest investments) while others have a variable rate of return (shares). Return can also come in the form of income (via interest or dividends) or capital gain (realised when an investment is sold for a profit), both of which have different tax implications.

Your needs or preference for types of returns will determine the type of investments selected.

Finding a balance

Risk and return are directly related. Higher risk investments often produce higher returns (or higher losses). Lower risk investments may mean lower returns. It is often quite difficult, if not impossible, to produce high returns with low risk.

The balance between risk and return will form the basis of your investment strategy.

Investment strategy

Diversification is a fundamental principle of wise investment and is a key element of your ability to reduce risk while achieving suitable returns.

Investors have a better chance of achieving consistent performance over the medium to long term by spreading their investments across a range of asset classes including cash, fixed interest, shares and property, and by having exposure to local and international markets.

The exposure levels to each of these asset classes will be determined by your investment objectives and risk/return profile. Your needs may change over time so it will be important to regularly monitor and update your investment strategy to account for these changes.

The following topics will help you address some specific issues that need to be considered when formulating your investment strategy:

Your investment choices

There are four main classes of assets in which you can invest:

Cash 

Cash covers deposits with banks, building societies and credit unions, and overnight market investments. Cash has the advantage of being relatively secure and easily accessible. Inflation has an adverse impact on its value.

Income investments 

In a basic sense, income investments involve lending money to a financial institution or company. In return, you receive regular interest payments for the term of the loan. Returns are usually higher than cash and fairly predictable. Most fixed interest products are reasonably secure but vary depending on the issuer and terms. In addition to the traditional range of securities, there is a growing pool of new and innovative investments to consider.

Shares

Shares represent your part ownership (or share) in a business which can be traded on the Australian Stock Exchange. Capital and income usually rises with inflation. Liquidity (ability to trade the shares) is usually good and gains are historically superior over the longer term. Volatility can affect returns over shorter time frames.

Property

Property investments are in real estate whether it be residential, commercial, retail or industrial properties. Property can be held directly or indirectly through a listed or unlisted property trust. Capital and income usually rises with inflation. Liquidity can be an issue and direct property often requires more maintenance than other types of investments.

Do you want to invest directly or indirectly?

Investing directly has the advantage of control, but the disadvantage of requiring hands-on management. Buying units in an investment trust (often called a managed fund) is an indirect way of making investments in shares, property, fixed interest or cash.

Investing indirectly enables you to achieve diversification more easily by pooling your funds with other investors and using the expertise of a professional manager to make investment decisions. The disadvantages are that fees may be higher than investing directly as they are ongoing rather than one off. The returns are also largely dependant on the skills of the fund’s management team which can be difficult to measure, except on an historical basis.

Investors can also choose to invest directly in some areas while using managed funds in more specialist investments such as overseas shares.

Do you want to be geared or ungeared?

If investment monies are borrowed, in whole or part, the investment is geared. By borrowing funds to invest, you considerably increase the risk associated with your investment but also increase your profit potential when returns are positive.

Gearing can be a very successful investment strategy but needs to be carefully considered as to whether it is appropriate for your needs. For more on gearing, read our page on Margin Lending, which is a specific type of investment gearing.

Managing your investments

A somewhat cumbersome but essential part of investing is the collection of all of your investment documentation, such as share trades, dividends or interest payments.

Many investors are time poor or have no wish to administer their investment portfolio and deal with all the paperwork.

Morgans has created a service that takes the hassle out of investing by collecting and recording all of your investment documentation. This service, called Wealth+, also provides you with regular reports to help you monitor your portfolio valuation and forecast income.

More information

ASIC has created a website called MoneySmart featuring information and tools to help people make the most of their money. It offers free, independent advice and is a useful online resource covering many topics. Visit www.moneysmart.gov.au to view.

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