How To Invest

Saving typically refers to putting money to one side, usually in a cash-based savings account. Here you will be paid a rate of interest and your money, or ‘capital’, will not be at risk. Under Australia’s financial claims scheme (FCS), deposits are protected for up to $250,000 for each account holder at each licensed bank, building society or credit union incorporated in Australia.

Over time, however, the purchasing power of money on deposit will be eroded by inflation. More on this below.

When you invest, you put your money into a range of different assets, from property to shares.

This differs from saving due to the uncertainty over the amount of money you will receive when you sell the asset. The value of the asset might rise, but you also risk making a loss if you have to sell the asset for a lower price than you paid.

So why do people choose to invest rather than save their money?

• Potential for higher returns: investors have the potential to earn higher returns on investments than savers with deposit accounts. However, as the CommBank notes, while returns have the potential to be much higher, they can also fall lower. Investing for the long-term is a great way to guard against this.
• Protect against inflation: inflation is currently at a record high of 6.1% in Australia, while the best high-interest savings accounts were still only paying half of that, topping out at around the mid to high 3% mark (as of October 2022). If you invest money in a savings account paying 3%, and the inflation rate is 6.1%, then you and your money are effectively going backwards. Investments have the potential to make higher returns to help counter inflation.
• Compound interest: compound growth occurs when any income or interest is reinvested and grows along with the original money or ‘capital’. As SuperGuide, points out: “When you are earning compound interest on an investment it means you not only receive interest on the principal invested but you also receive interest on your interest plus principal.” In fact, your superannuation is an excellent example of this. As your gains are reinvested, your investment pool ‘snowballs’ or compounds over time.

1. Do you have an emergency savings buffer?

The rule-of-thumb is to build an emergency fund to cover three or preferably six months of living expenses. This could cover unexpected costs such as car repairs or bridge a gap between jobs. It’s recommended this money is held in an high interest (or as high as you can find) savings account so you can withdraw it at short notice without penalties.

2. Do you have any high-interest debts?

If you have personal loans or credit card debt, it makes sense to repay these first if you’re being charged high interest rates. It may also be worth looking at cheaper options, such as a 0% balance transfer credit card or a lower interest personal loan.

The rough rule is that if you’re paying more in debt interest than your money is earning, you should use the money to pay down or clear the debt.

3. Do you understand the risks?

Although the risk varies by the type of investment, investing carries the risk of losing some, or all, of the money you invest. There is also a risk that returns might be lower than expected. You should not invest money if you are not comfortable in taking these risks. This is especially the case when it comes to cryptocurrency investments, which are yet to be regulated in Australia, and are notoriously volatile.

Before deciding on the type of investments to make, you should think through the following questions to help you make the right investment plan for your circumstances:

1. What are Your Financial Goals?

Start off by establishing your overall financial goals. Short-term goals might include buying a car or putting money aside for a deposit for a house in the next two or three years.

You might have medium-term goals, such as building up a fund to support your children, or going on a once-in-a-lifetime holiday.

Long-term goals might be to start contributing more to your superannuation to supplement the super guarantee.

It’s important to set your financial goals at the outset so that you can match the most suitable investments in terms of time periods, together with their associated risk and returns.

2. How Much Can You Afford to Invest?

Having put aside money for a rainy day fund, the next decision is how much to invest.

It’s a good idea to work out whether you have money left over at the end of the month after paying your expenses. If so, you might want to consider investing a regular amount every month to build up your investment pot over time. Or you might look at investing a lump-sum such as a bonus or inheritance.

Whichever option you choose, you should work out the amount of money that you are able to invest and whether you might need to access this money in an emergency.

3. How Much Risk are You Willing to Take?

On the whole, there is a correlation between risk and return—investors who are willing to take on a higher level of risk are potentially rewarded with a higher level of return.

Bonds (corporate or government) are generally viewed as a safer option. Government bonds, in particular, are considered low-risk investments and offer a fixed return or ‘yield’ based on their current trading price.

Investing in the stock market is higher risk, and as the last six months have shown, can be highly volatile even in Australia. But, it’s worth noting that the share market performs well over the long-term. Investment firm Vanguard has crunched the numbers and found that the ASX over the past 30 years has returned an average of 9.8% per annum, while US shares were slightly higher at 11.8% p.a.

Within the stock market itself, there’s a wide variation in risk and returns. For example, among the 57 investment sectors, Latin America delivered one of the highest returns of 5% by mid year in 2022, but after posting the lowest returns across the sectors in the previous two years, with negative returns of 12% and 15% in 2021 and 2020 respectively, based on data from Trustnet.

4. What is your time-frame?

Having decided on your financial goals, you should work out how long you want to invest your money for. In general, you should look to invest for at least five years: stock markets can fall, as well as rise, and this helps you to smooth out the average returns.

Investing for less than five years can present challenges. If you need to access your money at short notice, and your investments have temporarily fallen in value, you may be selling them at  a bad time.

If you may need to access your money in the next few years, you’d be better advised to keep your money in savings accounts where your capital is protected.

By the same token, if you are looking to invest for a longer period of time, such as for your super, you may choose higher-risk options as your investments have time to recover from any dip in value.

Whatever your chosen time period, it’s wise to change the balance of your portfolio as you approach the time to sell the investment. Selling a proportion of your stock market investments over time, and depositing the proceeds into a savings account, protects your money against a short-term fall in the stock market.

5. Are you Looking for Income or Capital Growth?

There are two types of return on investment: ‘capital’ growth (an increase in the value of your investment), and income.

With a savings account, you receive an income in the form of interest. With investments, it usually takes the form of dividends: these are cash payments made by a company to shareholders, usually on a yearly or half-yearly basis.

Although many people invest in the stock market for capital growth, the ability to produce an income stream can be useful. An income stream can also be used in retirement, while leaving the capital invested to grow in value and produce income in the future. Some property investors take this path when they invest in properties that are positively geared and offer a high rental yield. Many sacrifice capital growth in favour of this reliable rental income stream.

However, there can be a trade-off between income and capital growth. Some of the high-growth, US technology companies choose to reinvest surplus profits rather than pay a dividend, which should theoretically lead to higher capital growth. In contrast, some lower-growth, blue-chip companies in the UK pay regular dividends to shareholders.

There’s a wide choice of assets to invest in—from physical assets such as property, classic cars, fine wine and jewellery to financial assets such as shares, funds and bonds.

If you’re looking to invest in financial assets, it’s important to spread your investment across different asset types. A balanced and diversified portfolio helps to protect against one investment underperforming and may also smooth out the different levels of volatility.

Let’s take a closer look some of the options available to investors:

1. Shares

Buying shares in a company may reward investors with capital growth and an income in the form of dividends. There’s a wide choice on the ASX 200, including the big Australian companies, such as Telstra, Coles and the Commonwealth Bank. Some people invest in individual companies, while others spread their risk across a number of sectors and invest in the entire index.

One of the most common ways to do this is through an ETF or managed fund. You can also invest directly in the market through your super fund, many of which have at least some exposure to the share market.

However, investing in shares is a higher-risk option as the share price is impacted not only by the stock market as a whole, but also by company-specific factors.

2. Investing in passive funds such as ETFs

As mentioned above, passively managed fund, also known as a ‘tracker’ or ‘index’ fund, aims to replicate the performance of an index, such as the ASX 200 or the Nasdaq. The fund will buy all of the underlying shares in the index, usually in the same proportion as their market value.

Passive funds are also a low-cost option. Morningstar reports that average annual fees are 0.12% for passive funds, compared to 0.62% for actively-managed funds.

Passively managed funds come in different forms but exchange-traded funds (ETFs) are one of the most common types.

In addition to the main stock market indices, some of the more specialist ETFs also track commodity indices such as precious metals, crude oil and semiconductors.

Passive funds are a good option when stock markets are rising as they provide investors with the average return for the index without the risk of investing in one individual company. However, they are a higher-risk option in falling or volatile markets, as fund managers can’t take steps to protect against losses.

3. Investing in active funds

Actively managed investments pool together money from investors to be invested by a fund manager on their behalf. They charge a higher fee as the fund manager aims to outperform an index such as the ASX 200.

Depending on their investment mandate, they can invest in a range of different assets (e.g. shares, commodities and property), sectors (such as technology, healthcare and infrastructure) and geographies (including Australia, the US and emerging markets).

Usually, you buy units in these managed funds, the price of which fluctuates according to the performance of the underlying investments.

4. Investing in government and corporate bonds

Government and corporate bonds are considered the safest option as they offer a fixed rate of return. The advantage of this is that they do not fluctuate wildly like other investments, but the disadvantage is that without the lows there are no corresponding highs.

Of course, corporate bonds are considered somewhat riskier than government bonds, as there is a chance that the company may go under and imperil your investment.

5. Keeping your money in cash or term deposits

Other than stashing your money beneath a mattress, cash or term deposits, are the safest of all the options and, as a result, are never going to give retail investors earth-shattering returns.

High-interest savings accounts have been at record lows in Australia over the last few years, but with interest rates rising, pressure is building on banks to also lift their rates on savings accounts, and many are doing so. Even so, these returns are likely to be lower than Australia’s inflation rate.

Term deposits often involve a slightly higher interest rate than savings accounts, but there is usually a minimum amount to invest, often around $5000.

The advice and information provided by ForbesAdvisor is general in nature and is not intended to replace independent financial advice. ForbesAdvisor encourages readers to seek expert advice in relation to their own financial decisions and investments.