If you are looking to build wealth for the future, buying a lottery ticket probably isn’t the way to go. A far more reliable option is to invest – but unlike hitting the jackpot, investing takes time, patience and know-how. For many of us though, trying to understand investment-speak is like trying to learn another language. If that’s how it is for you, don’t despair – once you get your head around a few basic concepts, you’ll be on your way towards becoming a successful investor. Here are some simple definitions of a few common investment terms to get you started.
Your portfolio is the collection of assets you’ve invested in, which might include asset classes like cash, bonds, shares and property. You may hold different amounts of each asset and they’re all likely to have different values. As an investor, you can manage your own portfolio and choose which assets to buy and sell and at which time, or else you can hire a professional to manage it for you.
Cash refers to money you have that isn’t tied up in other assets. It’s easily accessible when you need it, and it has a clear, specific value. As well as the hard cash you have on hand, it may also include other forms of money that can readily be converted into cash if you need it, such as the balance of your savings account.
Investing in a bond essentially means lending money to the government or a company for a period of time, at either a fixed or variable interest rate. When you buy a bond, you receive a contract stating the interest rate and the maturity date – in other words, the date when the bond expires and you get your money back with interest. Also referred to as ‘fixed income securities’, bonds are generally considered to be a more secure investment than shares because you know exactly how much you’ll earn and when, similar to a term deposit. The main risk to be aware of is if the issuer cannot pay you back.
A share or stock is a portion of a company that’s available for investors to purchase. The amount of a company each investor owns is relative to the total number of shares available; for example, if a company has 100 shares and you buy one, then you become a shareholder who owns 1% of the company. Whenever the company returns a profit, you could be entitled to a dividend based on the portion you own. Keep in mind that shares are a long-term investment that may carry a higher degree of risk than other assets in your portfolio. Because they’re subject to stock market movements, they’re also likely to go up and down in value over the short-term – but they also have the potential to earn higher returns in the long run.
The most direct way to invest in property is to buy residential or commercial real estate and rent it out to a tenant. Your investment can then pay off in two ways, firstly through the rental income, and secondly as an asset if you sell it for a profit down the track. You can also invest in property indirectly through an Australian Real Estate Investment Trust (A-REIT). Like with a managed fund, A-REIT investors pool their money together in a shared portfolio of commercial and industrial real estate.
When deciding which investments are right for you, it is important to understand the trade-off between risk and return and how to manage investment risk. It is important to understand the different kinds of risk that may affect your investments. All investments carry some risk due to factors such as inflation, an economic downturn or a drop in a particular market. Even if you choose an investment traditionally considered ‘safe’, such as cash, there is still a risk of inflation eroding the value of your capital or falling interest rates reducing the level of your return. Every investment has the risk of not returning your investment due to market or manager risks. Assets with greater changes in their capital value and pricing will move around a lot more especially in the short term. It is important to know and understand the risks of every investment you make.
When you invest in a managed fund, your money is pooled together with the money of other investors. A fund manager is responsible for all the fund’s investment decisions regarding buying and selling assets. The fund can pay a regular income, but the amount can increase or decrease according to the performance of the fund’s assets. Although investing in a managed fund gives you less control than if you were to invest directly in shares, it may also give you access to a wider range of investment opportunities than you would have as a sole investor, may open up market and investment classes you otherwise would not have access to as a single investor and has the potential to minimize sector, or company, or country risk as funds may be invested across a wide array of investments, market sectors, or markets.
Asset allocation refers to the mix and value of the various assets in your portfolio. The key to getting the right mix is to weigh up your goals, your appetite for risk and the length of time you’re planning to invest. These factors will be different for everyone, so there’s no easy formula for asset allocation. Different asset classes each carry their own levels of risk and return. Generally speaking, ‘conservative’ assets like cash or bonds offer a safer but lower return than the potential returns on ‘growth’ assets like shares or property.
Diversification is a strategy for reducing risk in your portfolio. Since different assets are likely to perform better than others at different times, it’s a good idea to invest in a range of assets to reduce the risk in your portfolio. That way, when one type of investment is underperforming, your other investments will likely still be earning returns. For example, let’s say you’re only invested in shares. If there’s a downturn in the stock market, your entire portfolio will be negatively impacted. On the other hand, if half of your portfolio is invested in other assets, then that half of your portfolio may not be affected.
Your return on investment (ROI) is the amount you earn from an investment relative to how much it cost you. By applying this simple formula, you can compare different investments and their profitability: ROI = (Gain from investment – Cost of investment) Cost of investment, for instance, if you buy a house for $500,000 then sell it for $600,000, the gain minus the initial cost is $100,000. When you divide this by the cost, the ROI is $100,000 divided by $500,000, or 20%.
Capital gain is the profit you make when you sell an asset – in other words, the increase in value between what you originally paid for the asset and how much it sells for. If you sell an asset for less than you bought it for, this is called a capital loss. When you sell an asset, you generally need to report any net capital gains or losses in your tax return for that year. The net capital gain is the difference between the total capital gains for the year and the total capital losses less any relevant CGT discount or concession. Capital gains tax forms part of your income tax – any capital gain that is made is included in your assessable income.
The yield is the amount of income you receive from an investment, either as interest or dividends. Because yields can go up or down depending on how the market is performing, they’re usually calculated as an annual percentage based on the cost or value of the asset. But be warned: a yield isn’t a guarantee of specific returns. It’s simply an indicator of how a particular investment is currently performing or is likely to perform in the near future.
While it’s good to understand the basics, it’s important to be aware of just how complex these and other investment concepts really are. So, if you’re new to investing – or even if you’re a seasoned investor – be sure to talk to the team at Get Smart Financial Solutions today. We can give you the right guidance to make sure your investments are in line with your lifestyle needs and goals.
Get Smart Financial Solutions Pty Ltd is an Authorised Representative of Alliance Wealth Pty Ltd ABN 93 161 647 007 AFSL No. 449221. As an Australian Financial Services (AFS) Licence holder, Alliance Wealth Pty Ltd ABN 93 161 647 007, AFSL no. 449221 is a wholly owned subsidiary of Centrepoint Alliance Limited (Centrepoint Alliance), an ASX listed company; and a part of Centrepoint Alliance Financial Advice, the financial advice division of Centrepoint Alliance Level 9, 10 Bridge Street, Sydney NSW 2000. The information on this web page is not advice and is intended to provide general information only. It does not take into account your individual needs, objectives or personal circumstances.
Financial Planner/Risk Adviser
Authorised Representative of Count Financial Limited
Iain became a qualified Financial Adviser in 2010 and has worked in that role since that time. Prior to then Iain spent approximately 12 years in the finance and lending industry, four years in Small Business Management and six years in the Agricultural Industry. Iain attained his Diploma of Financial Planning in 2010 and completed his Advanced Diploma of Financial Planning in 2018. Iain is an associate member of the SMSF Association.