Getting Back To The Basics
Generally, when we refer to investing, we see this as putting time or effort into something that will provide a long-term benefit, such as an education or developing skills in some way.
When we talk about financially it’s more often with the view of investing money and often comes with the expectation of generating an income or profit with a long-term benefit.
The long-term benefits of investing are often with the goal of achieving the lifestyle you want to live. As advisers, it’s our hope that for most investors, growing their investments and savings isn’t about getting rich quick but about creating financial security and freedom to choose the life they want to lead – to put them in control.
With all the turmoil and uncertainty, we’ve experienced in the world in 2020 we thought it may be a great time to revisit the basics on different types of investments.
Share markets are moving constantly, there is much in the media around property prices dropping and cash rates are certainly not attractive in the long term. But all investments can have their place on your long- term wealth plans.
One of the most well-known types of investments are shares. Put simply, when you buy a share you are acquiring a small piece of ownership in a company.
You may have also heard shares referred to as stocks, and although they are often used interchangeably, there is a small difference.
When a company sells a portion of its ownership, it does so by issuing stock. The stock in a company is then divided into shares.
As you own part of the company, you are also entitled to part of the earnings of that company.
Profitable companies may therefore pay dividends, which is a way of distributing the earnings of the company to its shareholders.
In Australia companies pay a large proportion of their earnings out in dividends compared to many other countries in the world.
You can purchase shares through a share market, which is essentially one big auction house, where buyers and sellers list their respective buying and selling price, and when agreed upon pass on ownership of shares.
In Australia the main exchange is the Australian Securities Exchange (ASX).
Just to confuse you, the share market can be referred to as both the stock market and stock exchange, but this is just finance people enjoying having different names for the same thing.
Put simply, a bond is a loan.
When a company or government needs funds, they may issue bonds to borrow money.
When you buy a corporate bond, you are lending money to that company for a set amount of time in return for regular interest payments. As well as the interest payments, your initial investment will be repaid to you on a pre-determined date, known as the maturity date.
Think of it like taking out a loan from the bank, except the roles are flipped, with you paying the principal upfront and then receiving the interest payments.
Bonds, like cash, are considered a more defensive investment since they provide you with a predictable income.
Because there is more risk involved, bonds typically pay a higher interest rate than cash investments like term deposits. For example, if the company or government that issues the bond runs out of money and defaults on the loan, it’s possible you won’t get back the full amount you invested.
Lending money to governments is safer than lending money to a company, and as such government bonds generally pay lower interest than corporate bonds.
Some bonds can be traded on the share market, and there are even ETFs that track bond markets.
ETF stands for an Exchange Traded Fund.
An ETF is essentially just a basket of different shares that are pooled together into a single financial product that can be traded on the share market.
ETFs often track an underlying well-known index. An index is a hypothetical portfolio of shares that tracks a segment of the financial market.
The S&P/ASX 200, for example, tracks the performance of the 200 biggest company stocks in Australia.
So, an ETF that tracks the ASX 200 index will comprise the shares from those 200 companies and change in value in line with the index.
One of the main advantages of ETFs is that for a low cost they give you exposure to many different companies, diversifying your investment.
ETFs aren’t limited to tracking just the share market, and are available for many different types of assets, such as bonds, cash and commodities.
Investing in real estate has a unique position in the investment field.
Unlike the above investments, property is a physical, tangible object that you can see and touch.
Demand and supply for property is the main driver of real estate prices. There are many factors which influence the demand for property, but location is the main one. The main factor that affects the supply of property is unemployment.
Property investing is well understood by many. In Australia and many parts of the world there is a belief that property prices always rise. However, this may not be true and because there is no exchange where properties trade daily, their price is less transparent.
The downfall of property is the high entry and exit costs and having to pay interest if you need a loan to acquire the property.
The other downfall is the cost of maintaining the property. These costs create the possibility to lose money if your interest payments and maintenance costs are less than the income you earn from the rent and capital appreciation of the property. Property is also a highly illiquid asset, which means it’s difficult to convert the assets you own into cash.
Cash is what you keep in your bank account.
It represents the low risk, low reward option of the investment world.
In Australia, many cash deposits are guaranteed by the government, so they are very low risk.
When we talk about cash as investments, we focus on high interest savings accounts and term deposits. Term deposits are bank accounts where you cannot touch your cash for a specified number of months and usually receive a higher rate of interest.
The advantage of keeping money in cash is that it provides certainty (as long as the Australia government can pay) that you will get your money back when you need it, however this comes at the cost of low returns, which can be very low.
Currently we are living in a record low interest rate environment, with most of the interest earned from cash investments being wiped out by the increasing cost of living.
Where To From Here?
If you’re uncertain about where any of these investments fit within a well-diversified portfolio or you simply want to review your current holding we invite you to meet with our financial planning team to make sure that in looking at your assets the following are considered.
- Your tolerance to risk
- Your time frame for investing
- Your goals when investing
- Any income required from your investment
- Any tax issues