By Sheryl Sutherland*
Investing is not a complex task; moreover you don’t need large sums of money to build up a portfolio. All you need to do is to understand some basic principles. Believe me, the hardest thing about creating assets, money, wealth, a portfolio – or whatever you want to call it – is taking control of the ‘head stuff’.
Assuming therefore that you have your mental self firmly in control – in regards to money at least, the rest is beyond the scope of this article – let’s examine the building blocks you need to utilise to get started. Asset Classes Every prospectus or offer you read about refers to asset classes.
Different assets perform differently; for example property offers different returns to shares. Some will give you capital gain and fixed interest investments give you income.
Cash usually refers to money that is accessible, such as the folding stuff you’ve got tucked under the mattress, or the money in your savings account. Cash investments are low risk, low return and best used for short-term goals, or if you feel you may have to call on your funds at short notice.
Fixed interest investments such as government stock or debentures are next on the risk scale. Typically these are utilised by investors who want a fixed rate of return over a longer term, or for those who are setting up a diversified portfolio and who have a set investment term in mind.
The return on these investments is higher than that of cash. Bonds are classified as debt instruments. This simply means that you loan money to a company, or a financial institution, and it pays that money back together with interest.
The advantages as an investor are:
• you receive regular income from interest payments
• your capital investment is paid back to you at the end of a specified term
• these investments are much less volatile than equities (shares) with less risk of losing principal.
There is a downside with bonds: if you had bought bonds at say five per cent return and a new series is issued at say seven per cent, you would have made a loss.
Most of us automatically think of our own homes, but property investment is quite different. Investing in property can range from buying a rental property, to commercial or industrial buildings, to a block of flats. Property typically gives best returns in times of high inflation or when demand is high. Interestingly, despite our perception that property is ‘safe’, it is cyclical, and is actually somewhat riskier than we often think. Investing in property may, however, provide you with tax advantages.
Shares are also referred to as equities or stocks – the term ‘stock’ originated from loans made to merchants whose ships were bringing back stocks (goods) from other countries. Shares became available to the English public in the eighteenth century when trade, particularly with India, was growing quickly.
Today, if you buy shares, you buy a piece of a company. In return for your investment, the value of your shares may increase and you may also be paid a dividend. A dividend is returned to you in the form of an interest payment or in the form of additional share(s).
Historically, shares offer the best return of the main asset classes, but carry a higher degree of risk. The risk inherent in shares is volatility or sharp change in value, particularly in the short-term. The performance of the share price is reliant on company management and the overall economy.
In addition, people generally purchase shares when prices are high, instead of buying when prices are down. Historically, women have not been purchasers of shares, somewhat to their detriment. Shares are certainly a long-term investment, say five years at least.
Commodities are global contracts for bulk goods such as metals, energies, foods, and financial instruments. Metals include gold, nickel, and aluminium; energies include oils, coal, electricity; foods include pork bellies, coffee, orange juice; financial instruments are currencies, share market indices and interest rates.
Growth or Income Each asset class will provide you with different combinations of growth (capital gain) or income and, not surprisingly, different taxation implications.
Growth refers to an increase in value, for example if you buy a house for $120,000 and sell it for $150,000 you have a capital gain of $30,000. If you rent the house out, the rent you receive is income. Capital gain is generally a one-off profit derived on sale, while income is a stream of money, like your salary.
Examples of growth investments are property, shares, and commodities. Income investments are fixed interest. Shares can also provide an income stream in the form of dividends. Generally share and property investments provide higher growth and less income than fixed interest investments.
In Sheryl's next column, we look at risk and return.