What is investing?

Investing is a means of making your money grow in order to achieve future dreams and goals.  Investing is a way of making money from what you own.

There is a lot of jargon associated with investing, and this can make it seem confusing or more complicated than it really is.

You probably already know more about how investing works than you realise. Have you ever played Monopoly™?

Why invest? [Earn the return]

The short answer is “returns”.

You invest in order to earn a return on your money.  Depending on what you invest in, the return is generally made up of:

• Income
• Capital growth gain or loss (i.e. the difference between the price at which you sell an investment and the price you paid for the investment)

The advantage of investing for the long term is that when you invest you get the benefit of compounding returns, i.e. that you earn returns on your investments and then you get more returns on your investments earnings. The longer time you invest for, the more returns you could earn.

Before you invest

Before you consider investing, check off the following:

• Are your high interest debts such as credit cards paid off?
• Do you have an emergency fund in place to cope with life’s curve balls?
• Do you have money saved up that is not being used for anything specific?

Get educated

• Learn as much as you can about investments before you start investing. The links in this topic provide a good starting point for your investment learning. Make sure you fully understand how an investment works, before you commit to it. Knowledge helps you to make informed decisions about return and risk.

What do I want and when do I want it?

When you choose an investment, it should match up with your goals and timing.

What are your personal goals?

• Holiday
• Education
• Build a deposit for a home
• Develop financial independence
• Something else?

What is the timeframe for your goals?

• less than 1 year (immediate)
• 1-3 years (short term)
• 3-5 years (medium term)
• more than 5 years (long term)

For example, if you are planning to save for a house deposit within 3 years, you may prefer an investment that has a strong likelihood of growing steadily and not losing any value over that time, for example, saving in a bank account which pays interest.

If you are saving for your retirement, you have a very long time to achieve that goal, so you may prefer a higher risk/higher return investment. It has a greater chance of achieving the high return over the long term, but it is possible to lose value over the short to medium term. Shares are an example of a higher risk investment.

What about risk?

What is your attitude to risk? Your attitude to risk is personal and will influence the investments you choose.

Investments can provide the opportunity to make large amounts of money, but also to lose money – all investments have risks.

Investments can make large amounts of money, or lose money, or end up somewhere in the middle – all investments have risks.  Generally, investments that offer higher returns usually involve higher risk.

Some investment risks are:

• You could lose some of your initial investment (capital risk)
• The value of your investments may move up and down (volatility risk)
• It could take a long time to sell your investment and turn it into cash (liquidity risk)
• The investment you choose cannot earn enough return to achieve your goals (goal risk)

This means there is no such thing as an investment which will give you higher income, capital growth, accessibility at all times with no risk of loss.

Don’t put all your eggs in one basket

To help reduce risk, investors spread their money across a range of investments.  This concept is called diversification. This is similar to the old adage of ‘don’t put all your eggs in the same basket’. By spreading investments across different assets and different types of assets, investors reduce the risk that all of their assets lose money at the same time due to a specific event.

Be aware and protect yourself

Some handy tips:

• Any investment proposal that looks too good to be true, probably is – some examples are
  • investments with promised rates of return that are significantly higher than the current home loan interest rate
  • promised rental returns that are significantly higher than the rent for similar properties in the areas

• If you can’t understand the product, don’t invest in it – if you understand how an investment works, you will be confident in working out if it is going to help you to achieve your goals.

• Investments that are marketed as “tax effective” may be tax avoidance schemes so check with the Australian Tax Office 

• Take time to do your own research about the investment:
  • check that the company is real
  • get a second opinion from someone you trust

Types of investments

There are many different types of assets that investors can choose. The material in this program provides a starting point for your investment learning.

Some of the main types of investments, or asset classes, are:

• Cash – save money in a bank, building society, credit union, etc
• Fixed interest – lend money to a company or government
• Shares – buy part of a company
• Property – buy all or part of a building or block of land

Cash (typically)

• Earns interest
• Low risk
• Easy to access

Fixed interest (typically)

• Earns interest (higher than cash))
• Moderate risk –
  • bond prices change when interest rates change
  • can lose money if the company you lent to gets into difficulty

Shares (typically)

• Earns dividends
• Higher risk –
  • prices can go up (and down)
  • can be hard to sell at the price you want to sell at

Property (typically)

• Earns rent
• Moderate-high risk –
  • might be hard to find tenants
  • maintenance may be costly
• Can be hard to sell.

Fees and charges

There are a range of fees and charges associated with every investment.  Fees and charges will reduce how much money you have to invest. Some examples are:

• Banks can charge account keeping fees…
• Shares include commission charged by brokers….
• Property fees include State Government stamp duty…
• Managed Funds charge management fees

Some investments may have conditions, such as the interest rate paid on a bank account may depend on how many withdrawals are made in a month.

Ask for an explanation of all of the fees, charges and conditions before you invest. You can compare the fees and charges of similar products to get a good idea of what is fair and reasonable.

Don’t forget tax!

Make sure you understand the tax implications of your investments before committing to them. The Australian Tax Office is a source of reliable information about the tax rules for investing.

Making investment decisions

Seeking advice

There are many sources of advice about which investments to choose, including:

• Financial advisor
• Stockbroker
• Online trading forums
• Your own research from news articles, books, etc.
• Friends and/or family

When you are looking for investment advice, first ask yourself:

• Does the person giving advice have a licence to do so? A professionally trained and licensed adviser can help you to make the most of your money.

• If you follow the advice, is there any financial benefit (other than their fee) for the person who has given you the advice? What about if you don’t follow the advice? Ideally, there should be no difference to the advice-giver if you do or do not follow their advice.

• Do you understand how the investment works? Understanding an investment means that you will appreciate the risks and returns associated with the investment and be able to understand when an investment is performing better or worse than what you expected

ASIC’s MoneySmart website provides independent and reliable information about financial investment advice: ASIC MoneySmart Financial advice

Ways to Invest

You can choose to make investments in two main ways:

• Directly – you make the decisions and buy and sell assets yourself. For example, buying shares in a company, or buying an investment property.
• Indirectly – you give the decision making responsibility to an investment firm who buy investments on your behalf. For example, putting $5,000 into a managed fund whose performance matches the Australian share market.

The choice of investment method, direct or indirect, is personal and reflects your individual circumstances. The amount of money you have available to invest will influence your decision. For example, you can gain exposure to property through a small investment in a managed fund compared to the size of the deposit that is required for an investment property.

Direct investing gives investors complete autonomy over which assets they invest in, full knowledge of the fees involved in buying and selling the assets, and requires investors to fully understand the risks and returns associated with each asset they invest in.

Indirect investments, or managed funds, are run by investment professionals who make decisions about which assets to buy and sell and they charge a fee for their services.  The funds are pooled together with other investors. Individual investors do not have autonomy over the investment decisions but they also do not need to make their own risk and return analysis of each investment made within the fund, as the investment professionals do this.

You can gain exposure to property through investing in a managed fund, or by buying a property. You can invest in a fund with a much smaller amount of money than is needed for a deposit on a property.