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Investing Basics

Before investing your money, it is important to be aware of some key concepts which may affect your investments.

These include:

 What is an investment portfolio?

Your investment portfolio refers to the types of investments in which your total financial assets are invested. For many people, their largest lifestyle asset is their family home, and their largest investment asset is their superannuation or investment property. They may also have other savings in shares, term deposits and bank accounts.

 What are asset classes?

The four main asset classes used in IRIS are:

  • Cash (e.g. bank accounts)
  • Fixed interest (e.g. government bonds, corporate bonds)
  • Property (e.g. residential, commercial, industrial)
  • Shares (e.g. Australian & International shares)

Asset classes can broadly be separated into ‘defensive’ and ‘growth’ investments:

Defensive investments (cash and fixed interest)

  • Provide regular income and do not usually grow in capital value
  • Investment returns and values fluctuate only slightly over short periods
  • Over the medium to long-term, returns are generally lower than those of growth investments

Growth investments (property and shares)

  • Can provide growth in the value of your capital in addition to income
  • Investment returns can fluctuate significantly over short periods although over the medium to longterm, returns are potentially higher than those of defensive investments

 Risk and Return

Both ‘Defensive’ and ‘Growth’ investments have a different expected rate of return, and normally, the higher the expected return, the higher the associated risk.

All investments carry some risk. There are broadly three types of risk to consider:

  • The likelihood of not getting the expected return on the investment you are considering - including the possibility of losing some or all of your investment
  • The risk of volatility - where the value of some investments and their potential return may rise or fall from time to time due to market fluctuations 
  • The risk of being too cautious - if your money earns less than inflation then it loses its real purchasing power

These risks can generally be managed by assessing the investment you are considering and your own long-term financial situation and objectives.

We would normally expect that the more aggressively you invest, the more likely it is that you will achieve higher long term returns, but you also run the risk of short-term setbacks, as occurred in the Global Financial Crisis.

 Investment time frame

If you are intending to invest your money for a long time, ‘growth’ investments may be suitable. However, when you invest in assets that have the potential to provide generally higher returns you are also usually exposed to a higher level of risk.

If you are investing for a short time, ‘defensive’ investments may be a suitable approach. These assets are less likely to rise and fall in value from year to year and there is a lower chance of negative returns than for growth assets. When you invest in assets that have a lower level of risk you will also generally have lower returns over the long term.

 Diversification

By not investing all your funds into the one investment, or even the one asset class, you can significantly reduce the level of fluctuations in your investment value; that is, ‘not putting all of your eggs in the one basket’. This type of investment approach is known as diversification.

Diversification is not simply throwing your money around haphazardly into as many different investments as you can. It is about selecting investments that complement each other and perform well at different times of the economic cycle.

Knowing how much to invest in each asset class will depend on your personal circumstances, objectives, investment time frame and risk profile.

 

The information provided on this page is of a general nature only. It has been prepared by IFS without taking into account your personal objectives, financial situation or needs. You should assess your own financial situation and obtain independent financial advice before making any investment decisions or taking any action based on the limited information available on this website.

 

Last updated on 1st September 2016