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This chapter contains general factual information on the main investment areas and does not constitute financial advice. You should seek independent advice from an Australian Financial Services (AFS) licensee prior to making any investment decisions.

Financial advisers are often asked, ‘Where is the best place to invest my money?’ In asking such a question, their clients might be hoping to be told that there is one sure bet – for example, that shares are better than interest-paying investments or that property is the best method of increasing wealth. Of course, depending on your financial goals and objectives, one particular form of investment may be better than another for you at a particular point in your life. However, it is never advisable to have all your eggs in one basket. Even the so-called safe investments such as bank savings accounts involve an element of risk – most notably the risk of the value being eroded by inflation.

In general terms, there are four main types of investment, often referred to as asset classes:

• Cash – where you invest money in a building society, bank or other financial institution. Investment options include cash management accounts, and a major benefit of this investment type is liquidity.

• Fixed interest – where you invest in short- or long-term interest rate products that provide a steady income stream. Investment options include bonds, deposits, bank bills and various other types of securities. For more information on fixed-interest products, go to the ASX website: www.asx.com.au.

• Property – where you invest in residential, rural, industrial or commercial property. Depending on your retirement plans and financial objectives, your home may be included in this investment class.

• Shares – where you invest in companies listed on the ASX and other stock exchanges.

Investment considerations

Evaluating investment opportunities is easiest if you use a standard set of criteria to measure and compare them. Each investment should be evaluated in the context of your goals and objectives and then the following characteristics (among others) should be considered:

• return on investment

• capital and income security (or risk)

• ease of investment

• liquidity and other market conditions

• minimum investment

• costs

• time frame for performance

• choice and ability to diversify

• taxation.

Return on investment

Return on investment is usually in the form of income (a payment you receive from your investment) or capital growth (where the value of your investment increases over time). Some investments, such as shares or property, may provide both.

Income

Investment income includes amounts such as interest on bank accounts, dividends from shares, rent from a property and distributions from a trust. As well as the amount of income you are likely to receive, you should consider the likely frequency of the payments and the potential for any increases or bonuses. As income from investments is usually subject to income tax at your marginal tax rate, you should always take the income provided after tax into account. Some forms of investment income, such as fully franked dividends, may provide some investors with tax benefits; however, we recommend that you obtain your own taxation advice from a professional adviser before making any investment decisions.

Capital growth

Returns from capital growth can only be realised when you sell an investment for more than the purchase price. The main benefit of capital growth is that it protects you against inflation. Capital growth may occur through rising share and unit trust prices on the sharemarket, increased values in the property market, and/or profit on fixed-interest securities if sold before maturity. Realised capital growth from investments is usually subject to capital gains tax.

Visit the website of the Australian Taxation Office (www.ato.gov.au) for up-to-date information on tax matters.

Capital and income security

How secure is your investment capital? Is it possible your investment will be worth less when you wish to sell it? Will you be able to sell it at all if there is a shortage of buyers or if the financial institution you have invested in defaults? By answering these questions you are identifying your risk of capital loss.

In addition to your capital, how secure is the income from your investment? For example, in the case of an investment property, will there always be a tenant to pay rent? This is an important consideration if you are relying on investment income to supplement your income from other sources or to support your lifestyle. In addition, unreliable or fluctuating income may affect the sale price or capital gain of your investment.

When considering capital and income security, it is important to take into account price volatility and the risk/reward equation.

Volatility

Volatility refers to the general tendency of the price of an investment to fluctuate as buyers and sellers enter and leave the market.

Short-term price fluctuations matter less when you invest for the long term and when the price is expected to rise overall during the period of investment. Whereas a three-year investment is usually considered to be short term, a long-term investment can be seven years or more.

If you sold your house on seven different days, you would get a different price each day. In the short term, the sharemarket really isn’t all that different.

The risk/return equation

The risk/return equation balances the possible risk (of loss) against the possible return (or profit) of an investment.

You should only invest as much in high-risk investments as you are prepared to lose. For example, ‘safe’ or low-risk investments such as bank accounts often pay lower rates of interest or offer lower returns, while high-risk investments often provide an opportunity for higher rates of return.

Ease of investment

Ease of investment is another important consideration when deciding which asset class to invest in. Look at how hard it is to enter the asset class and what processes you need to go through when you decide to exit. For example, if you know how difficult it can be to find a suitable investment property, negotiate the price and arrange settlement, you will be pleased to find out that establishing an account with a stockbroker is as easy as opening a bank account. Having opened your account, you can buy and sell shares by giving instructions to your stockbroker over the telephone. Alternatively, you can use an online broker. Share prices are listed daily in the major newspapers and may be accessed online. ASX operates from 10 am to 4 pm Eastern Standard Time, Monday to Friday (excluding national holidays).

The ASX trading calendar, market hours and trading phases can be found on the ASX website: www.asx.com.au.

Liquidity and other market conditions

Investments with high liquidity not only make investing easier but, by allowing you to exit your investments easily, provide you with greater access to your money should you need it.

Share prices are determined by the buyers and sellers through the power of supply and demand, and trading may take place instantaneously. There is usually a healthy number of buyers and sellers for shares in most of the major companies. These are known as liquid stocks. However, the Australian market is noted for having a ‘long tail’. This means that liquidity is quite concentrated and can trail off considerably outside the top 200 companies (and sometimes for stocks, within the top 200). You can readily determine how liquid the market for the shares in a particular company are by monitoring how many shares are sold on a daily or weekly basis. Another test of liquidity is how wide the spread is between the bid (the highest price people are prepared to pay) and the offer (the lowest price people are prepared to sell at). When there are lots of buyers and sellers, both sides compete to get their trade done so buyers are prepared to pay more and sellers are prepared to accept less, resulting in a narrowing of the bid/offer spread.

Interest-bearing investments also have a degree of liquidity. Generally speaking, the least liquid asset class is property: investors in this asset class may need to wait for the opportunity to realise any capital gain.

Minimum investment

The minimum investment for a particular asset class is another important consideration, as the amount required may prove to be prohibitive for some investors. In the case of share investment, some stockbrokers will accept an initial investment of as little as $500, but bear in mind your transaction costs (principally brokerage) if intending to make repeated small investments (see the section on ‘Costs’ that follows). Cash investments and managed funds also have low entry levels. While direct property has a higher entry level (usually at least $150 000), you can gain exposure to property using much less capital if you invest through a property trust (there is more on property trusts later in this chapter).

Costs

Investments often involve transaction costs when you buy or sell, as well as ongoing costs of ownership, and these must be taken into account when comparing asset classes. Transaction costs for direct sharemarket investments include brokerage payable to your stockbroker plus GST. There is no stamp duty payable on share transactions and there are no ongoing costs for direct sharemarket investments.

For other investments, transaction costs may include government charges, real estate agent commissions, entry and exit fees for managed funds and bank charges. Ongoing costs may include building maintenance, rates and letting agent fees, fund management fees and account fees.

Time frame for performance

The time frame required for your investment to perform is also an important consideration – some investments are better for long-term goals and others are more suited to short-term goals. The key determinants are the time left until the particular investment reaches maturity (the point at which you will be able to sell it) and/or the time required for it to perform to the desired standards.

Generally, shares do not have a maturity date and can exist for as long as the company is in operation. This means you can invest by taking a long-term view on performance. On the other hand, you can also take a short-term view. Day-traders aim to have opened a position and closed it out within the day, hence the name.

Property is generally considered as more of a long-term investment.

Two further considerations when determining the time frame you are prepared to accept for your investment to perform are the time it takes to invest and market timing.

Time it takes to invest

While ease of investment has already been discussed, the time it takes to be able to invest is also an important consideration. It takes time to learn to invest effectively – that is, time to learn about your investment alternatives, time to make investment decisions and time to manage your investments thereafter. Many people feel it is easier to invest in areas such as the cash market or managed funds than in areas such as property and the sharemarket.

Depending on the amount of time you have and your level of interest, you can:

• make all your sharemarket investment decisions by yourself

• rely more on the advice of your stockbroker

• make an indirect investment through a reputable fund manager.

The same applies to property – you can either research and decide on specific properties directly, or invest indirectly via listed or unlisted property trusts.

Of course, investment decisions become easier as you gain experience and learn more about the factors affecting your investment.

Timing

The timing of your investment in a particular asset class is also something to consider. Timing is particularly important when deciding when to buy or sell an investment in markets that have poor liquidity (a relative lack of buyers and sellers), as this characteristic tends to produce large price swings. Timing is also important for investors pursuing short-term investment returns or wanting to lock in capital gains. However, as most share investors are in the market for the medium to long term, the issue is not so much one of market timing as it is of their willingness to let time pass.

Choice and ability to diversify

The companies listed on the ASX include a number of large overseas-based companies. More than two-thirds of the listed companies are industrial, which includes businesses such as banking and retail. The remainder are part of the resource sector, which includes mining and exploration. Many listed companies are household names – for example, BHP Billiton, Westpac, Woolworths, Telstra and the Commonwealth Bank.

As an alternative, managed funds are popular because they provide investors with a cost-effective way to spread (diversify) their investment throughout local and overseas sharemarkets, as well as over other asset types, such as property and cash.

Another possibility is the growing range of exchange-traded products, including exchange traded funds (ETFs), which can give you quick exposure to a range of diverse assets with relatively low management fees. We talk about these more in chapter 10.

As well as internal diversification, another factor to take into account is which asset classes enable you to spread your investments over different levels of debt. The movements of interest rates paid and charged by banks have an effect on us all. For instance, if your bank increases its interest rates, the repayments on your mortgage are also likely to increase. Like most individuals, companies listed on the sharemarket have debts that need to be serviced. These debts, like a mortgage, are susceptible to movements in interest rates charged by the lender.

Direct property investment may offer fewer opportunities for internal diversification and spread of debt levels due to the amount of capital needed for each investment.

Taxation

Taxation can influence returns on investments significantly so it is an important consideration. However, don’t let it be the sole determinant when making your investment decisions.

Characteristics of the asset classes

This section looks at the characteristics of the different asset classes. After cash, fixed-interest investments and property, the potential benefits and drawbacks of share investment are discussed in greater depth.

Cash and interest-bearing investments

Cash

The features of cash include:

• it usually provides the highest liquidity with the lowest risk