investing

investing

  • At the most basic level, investing is placing funds towards some sort of asset with the plan that you will gain some financial returns in the future.
  • There is always some level of risk, with large degrees of variation depending on what type of investments you partake in.
  • In order to fund an investment you either need access to savings, or you can borrow money (known as leveraging). In many cases with investment banks and businesses, a mixture of the two is taken.
  • Traditional investments bring profits in two ways. Many asset types bring income; a regular series of cash flows, or they may grow in value – in a lot of cases investors will hope for both.

asset classes

  • There are many different types of asset classes or types and each will have their differing levels of risk and return. Deciding on an asset class will depend on an investor’s risk tolerance, which is how much risk they are willing to take on while looking at investments. As a rule, they’ll attempt to minimize their risk while maximizing their returns.
  • There are five main different classes – these will be covered in greater depth in subsequent videos:
  • Tip: you can compare the historical performance of asset classes using Vanguard’s Interactive Index Chart.

cash

  • This is considered as the safest asset class, meaning it will have the lowest risk but it will also generally have the lowest return, based off of historical performance.
  • Investing cash can be as simple as holding the money in interest generating accounts.
  • In Australia, the government will also guarantee your deposits in Authorised Deposit-taking Institutions (ADIs) up to an amount of $250,000 so that if anything were to happen to the bank, you would still be in possession of your money (up to that $250,000 limit).
  • Other forms of cash investments are treasury notes and commercial bills. Despite them possibly having greater returns, they are also are more difficult to access and are traditionally owned by larger institutions.

fixed interest

  • In order to raise funds, corporations, governments and other similar entities may offer fixed interest instruments in the form of bonds. These will generally pay both a periodic interest payment (the coupon), as well as the full amount (the face value, or principal) at the end of the term.
  • On offering bonds, the issuer must document the coupon rate, the periodicity of the coupon, the principal and the maturity date – which is when the principal is due.
  • An attractive feature of bonds is that they can be bought and sold. In a normal case, when lending money to an individual, you may not see your money until they have paid it back.
  • When holding bonds, if you don’t want to wait for the full term then you can sell them to another party in order to get your money back sooner, at the cost of any change in value in the bond as well as missing out on any future returns.
  • Bonds can be bought and sold on a financial exchange, and traditionally offer a bridge in risk and return between cash investments and equities.

property

  • When investing in property, you can look at two forms of returns. Income can be generated from rent, while the value of the property may also appreciate over time so that it can be sold for a capital gain.
  • The most straightforward method of property investment is to buy it yourself and then rent it out for income. This will often take a very large sum of money, accessed through a lot of savings or a sizeable loan – both of which may not be accessible to many people.
  • If you only have access to a smaller sum, or don’t want to expose too much of your portfolio to property, then you can access property through managed investments. In a nutshell, a managed investment will pool together money from different sources and then a fund manager will make purchases on behalf of the investors.

equity

  • Equities, or shares, represent a portion of ownership in a company. Each share will hold some financial value, and if it is traded publicly, this value will be determined by the buyers and sellers of the shares on a financial exchange. The movement in price will determine whether the investor will make a capital gain or a loss, depending on the original cost of the share.
  • As a part owner of a company, a shareholder is entitled to a proportionate amount of profit in any given year. This figure is generally given by an earnings per share; available in an annual report. Although a shareholder may be entitled to the profit, the company can decide whether the profit is actually paid out in a dividend or to reinvest it back for the sake of future growth.
  • On weekdays, investors can buy and sell their shares on an exchange. In Australia, this is the Australian Securities Exchange (ASX), although most countries with a large enough share trading market will have their own.

alternative

  • Assets in this class tend to be more unpredictable in nature, and are generally less correlated to given benchmarks than other asset classes. Alternatives can be used to diversify an investor’s portfolio, or they may have the view that they will outperform other asset classes in a given timeframe.
  • Some common alternative investments are commodities and currencies. Both of these can be found on exchanges, however in Australia they’re separate from the ASX. Their values are determined by the supply and demand of each underlying asset; for commodities this could be anything from food to oil. Currency values are quoted against another country’s on a per single unit basis. For example, in the United States, they would quote values as per one U.S. dollar. These two types of investments don’t provide any income stream and profit is usually made through capital gains.
  • Mortgage backed securities (MBS) are a pool of multiple mortgages entitling investors to a proportionate amount of interest and principal. Defaulting on mortgages (failure to meet debt obligations) will result in a drop in value of an MBS which is where a lot of the risk lies in this investment type.
  • If an asset is expected to appreciate in value, some investors may put money towards real world assets. These are purchased privately meaning that there won’t be a given value for each unlike something traded on an exchange. These assets do provide tangibility though and some may be used in daily life to the benefit of an investor before being sold.

investment portfolio

  • In putting together a group of assets, an investor creates a portfolio.
  • Having a largely varied collection of instruments insulates an investor from the risk of certain assets or groups of assets losing a lot of their value. This is known as diversification, which is the act of spreading risk.
  • There are multiple ways in which an investor can look to diversify their portfolio; increasing the number of investments, varying the portfolio’s asset classes, looking into different industry sectors, and investing in different geographical regions.

financial exchanges & stockbrokers

  • An investor is likely to come across two organizations when investing; brokers and exchanges.
  • An exchange acts as a marketplace for buyers and sellers where shares can be traded, while the stockbroker facilitates trades between the two parties.
  • A broker can make profit from the usage of both ‘bid and ask spreads’, as well as including a brokerage fee with each trade they have made on the behalf of each investor.
  • Tip: you can compare a range of stockbrokers at Canstar and Cheap Brokerage.

getting started

  • To start investing in listed securities, the above video will go through the following steps:
    • Apply for a brokerage account
    • Funds transfer
    • Placing an order
  • In the process of placing an order, there are a few issues to consider. On top of the more apparent decisions needed to be made such as choosing which equity to trade, the quantity wanted, and whether you will wish to buy or sell, brokerage platforms will offer some more customization options to best suit an investor including whether there is a market or limit price on the order, as well as the length of time that the order will be valid.

practical steps

Step 1

After having navigated through each of the topics about asset classes, do some of your own research on each asset class. Try to understand some of the investments within those asset classes. For example:

Fixed Interest – try to look at a handful of 5 ASX listed bonds (both Australian Government and corporate). When researching, try to find credit ratings reports on these entities / organisations (Standard & Poors, Moody’s, and Fitch are some ratings agencies). These reports will provide an overview of their credit history and worthiness (note that these reports can be tough reads).

Property – try to stay up to date with property trends in your local area, and in other areas if interest takes you there. Remember to divide your research up between residential and commercial properties as these markets can differ. Websites like Domain and Real Estate have tools that enable you to conduct suburb price and rent analysis.

Equities – try to look at a handful of 5 ASX listed companies. Look at the history of their share prices and the historical dividend yields (the dividend payment as a percentage of your initial investment). Look through the companies’ annual reports to develop of an understanding how the company operates, and their strategies for the future.

 

Step 2

When approaching ASX listed securities, make sure you check out online modules on the ASX Education portal. This will provide more information as to how each specific security works and how they can be traded.

 

Step 3

Find out your risk profile. You can find this out using BT’s risk profile survey. This will provide you with some indication (it is not a perfect science!) of how much risk you should be adopting around your investment portfolio. Note that financial planners are able to provide more specific advice around how you should construct an investment portfolio, based on more personal information.

 

Step 4

If you opt not to use a financial planner – you need to decide whether you want to build an investment portfolio picking investments yourself, or whether you want to use managed investments (see Managed Investments module for more information). There is no correct approach.

 

Step 5

If you decide to pick investments yourself, then make sure you conduct further research into specific investments before making decisions. Make sure that you compare stockbrokers, real estate agents, and other relevant intermediaries thoroughly before selecting one because costs of services can vastly differ.

 

Step 6

Monitor your portfolio on a regular basis (e.g. 3-6 months). Review how different markets have been trending. Check to see if dividends, coupons, or other investment income are being paid to you correctly – to avoid hassles, you can elect to have these sent directly to your bank account (otherwise they will arrive as a cheque in the mail).

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