Guide to Investments

Guide to Investments Why invest? People invest for two basic reasons: 1. Future income and to see their money grow – to meet future needs or expenses, provide for retirement or to leave some money for their family; or 2. Inflation protection – to maintain the value or purchasing power of their money. Know your investment options . There are four main types of investments called ‘asset classes’. Asset classes are the building blocks that provide investment opportunities. They are:  Shares – a basic unit of ownership of a company.     Investors who buy shares are usually entitled to share in company profits in the form of dividends and any capital growth. Shares can be bought by ‘direct’ investment in companies listed on the Australian Stock Exchange and international share markets, or ‘indirect’ investment in managed funds which hold shares in a selection of companies. ‘Equities’ is another name for shares.  Property – like shares, an investment in property involves ownership.    Property investment can be a ‘direct’ investment in property assets (such as houses, offices or factories), or an ‘indirect’ investment in a property trust, which holds assets in a selection of properties. Property trusts can be listed on a stock exchange.  Fixed interest (bonds) – an investment in fixedinterest securities such as bonds issued by companies or governments. They earn a set rate of interest over a fixed period of time. Cash – includes assets that can be readily converted to cash with lower risk of capital loss. Cash usually means notes and coins but also includes short-term interest-bearing investments, such as bank bills or commercial bills, term deposits and cash management accounts.  Set investment goals Saving is about accumulating a certain amount of money for a certain goal Investing involves putting your money to work so that it can earn even more money – in other words, it’s about building wealth. Over the long term, investing can be a means to achieving life’s more significant goals, such as:  saving for an overseas trip;  buying a house;  building up a reserve to pay for your children’s university education; or  funding your own retirement.  A financial planner meets with the client and conducts a detailed assessment of their financial situation, needs and investment objectives, and develops a plan that’s tailored to their requirements. Consider the clients time frame   Does your client want to invest some money over a short time frame to put towards a house deposit or an overseas trip? Would they like to invest over many years to build a retirement nest egg? Time is one of the keys to successful investing, especially when investing in riskier asset classes.  Short-term ups and downs in more volatile asset classes (like shares) tend to average out over longer periods. Although past performance is no guarantee of future performance, statistical data over the past 50 years shows that over the long term, shares have produced better returns over property, and property has produced better returns than fixed interest. Cash has produced the lowest returns over time.  Consider the clients time frame  As a general rule, the riskier the asset class and the higher the returns the client requires, the more prepared they will need to be to leave their money invested for long time frames, and the more equipped they will need to be to deal with the potential for loss over shorter time frames. There is always the potential that value on investments may be lost over time, even if they are invested over the long term.    Financial goals, level of risk and investment types will help determine how long the client needs to invest. Longer-term investments can also benefit from compounding interest to increase the investment value depending on what happens in investment markets and the economy. Work out how much they can invest   All it takes to start investing is a small amount of money from each pay (you don’t have to have saved a big lump sum). Recommend that your client starts a budget to see if they can accommodate a regular investment account. Recommendations for planning and saving. Money Guide  Here are ten things you can do to get started with planning and saving. 1. Know your finances 2. Set SMART goals 3. Separate needs from wants 4. Create a realistic budget 5. Minimise spending leaks 6. Pay yourself first 7. Open a savings account 8. Look for the best interest 9. Know what you are paying when you use credit 10. Shop smart 1. Know your finances In order to plan and save effectively you should know:  How much money is in your everyday bank account (to the nearest $100)?  What fees do you pay on your bank accounts?  When are regular household bills such as electricity and telephone due?  What do you spend on living expenses and bills each month (to the nearest $100)?  How much is owing on your personal loans and other debts (to the nearest $500)?  How much is owing on your mortgage (to the nearest $1,000)?  What are the interest rates on your mortgage, personal loans or other debts?  How much money is in your super fund (to the nearest $1,000) and what fees do you pay? 2. Set SMART goals Write down what you want to achieve financially. Include short-term goals such as paying off a credit card, or buying a computer, as well as long-term goals such as saving for a house or for retirement, or paying off the mortgage. This process will give you purpose and motivation for creating a savings plan. Make sure the goals you set are SMART goals:  Specific - You know exactly what the goal is.  Measurable - You are able to measure how far you have progressed towards the final goal.  Achievable - The goal takes account of your particular situation at the time.  Realistic - The goal reflects your skills, resources and ability to achieve a specific outcome.  Timed - There is a definite time frame against which progress towards the goal can be tracked. 3. Separate needs from wants To save money to achieve your goals you will need to make choices about the items you spend money on. Separating the items you really need from those that you want can help you:     work out your spending priorities; save money; avoid impulse buying; and get value for money. 4. Create a realistic budget A budget can help you identify areas where you can cut back your spending and allocate money to savings. To create a realistic budget:       Decide what timeframe you want your budget to cover (e.g. same as your pay period). Write down your after tax income sources, expenses and repayments. Give yourself an allowance for a treat. Allocate an amount to emergencies and unexpected expenses. Add up all of your expenses and spending, then subtract the total from the amount of income you receive. The balance should correspond to the amount you want to save. Review your budget regularly to make sure you are sticking to the plan. 5. Minimise spending leaks Spending leaks are generally small expenses (e.g. take-away coffee) that you easily forget to include in a budget, but that can add up to a lot of money over time.  A spending diary can help you to identify spending leaks for small items. This is what a spending diary might look like: Tuesday $2.50 - Coffee $18.00 - Lunch $78.00 - Shoe Sale $300.00 - Electricity bill 6. Pay yourself first   Developing the habit of 'paying yourself first' makes saving a priority and provides a way of gaining control over your financial future. This means deliberately putting away a specific amount of money towards your savings goal from every week's income. This can help you reach your goal more efficiently than saving only what remains at the end of the week 7. Keep savings separate Some of the options generally available for saving money include:  Savings accounts - Things to look for when selecting a savings account include low fees or no fees and high interest. Also consider an account with no ATM access to make it harder to withdraw money unless you really need it.  Term deposits - These earn you higher interest than an ordinary savings account. Because they're for a fixed term, you generally can't get access to your money without a penalty until the term ends.  Cash management accounts - These are similar to transaction accounts but they usually pay higher interest, and the rates can be tiered - so the higher the account balance, the higher the interest earned. They usually require a minimum amount before they can be opened.  Whatever option you decide to go for, always make sure you are aware of the fees and charges that apply to different situations 8. Look for the best interest The type of interest you want will vary depending on whether you are saving or borrowing. Different types of interest include:  Simple interest (payable) - interest is charged on a set amount of initial principal that is lent.  Reducible interest - calculated on how much you owe each day, after reductions made by your payments.  Fixed Interest - the rate charged stays the same for a specified period.  Variable interest - the interest rate charged might change during the term of the loan.  Simple interest (earned) - interest is paid on the initial set amount of your savings only.  Compound interest - when interest is earned on your savings, both the original amount and the interest is calculated into a total sum. The next interest payment is calculated on this new total, not the original savings amount. 9. Know what you are paying when you use credit Before making a purchase on credit ask yourself:  Do I really need this item?  Must I have it right now; are there other alternatives?  Is this the most effective use of my income?  Can I wait until I have cash to pay for it?  How will I pay for it - cash, credit card or loan?  What will the item cost when the loan or card interest is added?  Can I afford the regular repayment amount?  Can I pay off the debt within the interest-free period?  What are the extra charges apart from the interest?  Is there a penalty if I pay the loan off early?  How long will I be paying the loan? 10. Shop smart Tips for smart weekly shopping:  Always write a shopping list.  Have an idea of how much the shopping should cost and try not to go over that amount.  Think about whether you need or just want an item.  Never shop when you are hungry.  Know when items are really cheap, and buy regular goods in bulk when they're on special.  Do research and find out where products are cheaper - for example, is it cheaper to buy meat from the butcher or the supermarket?  Think about the food you threw out last week and don't buy that again.  Beware of the 'I deserve it' mentality when deciding whether to buy a product.  Shop alone so your friends and family don't tempt you to buy things that are beyond your budget.  Clear your purse out every night and put all coins in a jar to be banked monthly.  Keep some 'mad' money each month to spend on a treat Consider how much risk your clients are prepared to take on     All investments involve some level of risk, though some more than others. Generally speaking, if the expected return from an investment is above average, then the risk associated with the investment is usually above average. The lower the likely returns, the lower the level of risk. This is called the risk/return ‘trade-off’. There are ways of managing investments to reduce the amount of risk you are exposed to, including:  Diversification – that is, spreading money across a range of different types of investments.  Taking a long-term view and investing money for longer periods of time to reduce the impact of short-term ups and downs (volatility) on investments. Diversification of investments     You can diversify across asset classes by investing in every asset class or, you can diversify within an asset class by choosing to invest in a range of small to large companies or companies in different industry sectors such as resources or industrial companies. You can also invest in a managed fund that invests in many different Australian companies, or in a number of different types of managed funds, rather than just owning shares in one big company and leaving it at that. How does diversification help? If you’ve got a number of different investments across a range of asset classes, industry sectors or managed funds, then a significant loss of value on one of the investments is likely to have a lower impact on the overall portfolio. As well as helping to reduce the overall risk, diversifying also means the portfolio has more potential to benefit from strong investment returns, because the investments are in several different types of assets. Take advantage of compounding interest  One strategy, when it comes to investing, is simply to start with a little bit of money and add to it bit by bit over time. Then let compounding get to work and boost your investment over time. Take the example of Edward and Frank.  Edward invested $2,000 a year from the age of 25 until the age of 60, so in total he invested $72,000.  Frank invested $5,000 a year from the age of 40 until the age of 60, so he invested $105,000.  Edward now has $372,204 which is $100,000 more than Frank’s $247,115. Even though Edward contributed less, he was in the market for longer so he had more time for interest on his investments to accrue – not only against his initial investment, but also against any interest that had already been earned.   Compounding provides a compelling reason to start sooner rather than later, and to make a start with whatever you have on hand…just so long as you make a start. Consult ASIC’s FIDO website to see how compounding can increase your investment over time: Compound Interest Calculator  Wealth building via regular savings   Another wealth-building strategy is to add to current investments with regular instalments. Regular instalments, means building investments earlier and having longer time to take advantage of compounding. It also means that you can dollar cost average. Dollar cost averaging is a strategy that simply means investing a set amount of money at regular intervals over a long period of time, as opposed to investing all of the money at once. The money could gain an advantage from rises and falls in the investment prices over a period of time by buying more when the price is low and less when the price is high. Gearing to boost investments     Gearing is borrowing money to invest. By borrowing money to invest, the size of the investment portfolio increases and consequently magnifies the potential investment returns. It’s important to remember though, that gearing can magnify returns in both directions – that is, it can magnify positive returns and losses. Some pros... By increasing the value of the investment portfolio, gearing can assist the client in reaching their financial goals faster. A gearing strategy can provide greater scope to diversify by providing a larger pool of money to invest. Also by investing large amounts, investment entry costs can often be reduced. Some cons... Gearing can be a high-return strategy, but that means it can also be a high-risk strategy. Never borrow more than you can afford to repay. If the investment performs poorly, not only will they have to cope with any losses in the investment’s value, they will also still have a debt to repay. Regularly review the portfolios  Take the opportunity to analyse the performance of the portfolio on a regular bases.    How are they performing? Are they meeting the clients expectations? Have their circumstances changed since their original investment and, if so, is their investment plan still aligned with those needs?