Building your wealth for the long term starts with a sound investment strategy; but with so many options outside your superannuation fund, from bonds to managed funds, where should you begin?
Understand your risk profile and timeframe
Almost every type of investment comes with some level of risk. There’s a risk you could lose money, as well as the possibility your investments won’t achieve your financial goals within the timeframe you need. As a general rule, the higher the risk the greater the potential return and the longer you should consider keeping that investment.
So first you need to understand what type of investor you are and recognise that this may change as you get closer to retirement.
When time is on your side, you may decide you can afford to take some calculated risks with your investment portfolio. That might place you at the ‘aggressive’ or ‘moderate to high growth’ end of the risk profile spectrum but if you’re planning to scale back on paid work soon, you may feel more ‘defensive’ or ‘conservative’ with your investment approach, to protect the value of the capital you’ve already built up.
To work out your risk profile, think about how you feel about short term fluctuations in the value of your investments. Would it keep you awake at night or would you be comfortable riding it out?
A market correction when you’re close to retirement could have a disproportionate impact on a larger portfolio so it’s also worth considering two risk profiles, one for your superannuation and one for your other investments.
What are asset classes?
An asset class is a type of investment – broadly speaking, these are cash, fixed interest, property or shares. Each has a different level of risk and return.
Cash (defensive asset)
Fixed interest (defensive asset)
Investing in cash (such as term deposits) provides stable, low risk income (usually as interest payments). Traditionally, around 30 percent of assets are held in cash and term deposits. It’s a good idea to have some cash available at short notice and these investments usually have a short timeframe.
Investing in government or corporate bonds, mortgages or hybrid securities operate like a reverse loan – they pay you a regular interest payment over a fixed term. You usually hold fixed interest investments for one to three years.
Property securities (growth asset)
Australian and international shares (growth asset)
You can invest in property that is listed on share markets, including commercial, retail, hotel and industrial property. The potential returns can be medium to high but you may need to hold these investments for three to five years.
Shares (or equities) give you a part ownership of an Australian or international company. Your potential returns include capital growth (or loss) and income through dividends, which may be franked. Depending on the type of share, these are considered medium to high growth assets and you may need to hold them for up to seven years.
All about diversification
Spreading your investments across a range of assets to reduce your risk is known as diversification – basically it lets you avoid putting all your eggs in one basket.
Diversification can reduce the volatility within your portfolio and the risk of a large drop due to any market downturn. Given it can also take time to sell certain investments (such as property), it’s smart to have short term as well as long term investments within your portfolio. There are no guarantees – diversification won’t fully protect you against loss but it can even out your returns.
Other ways to invest in shares
Investing in a managed fund gives you access to different equities, bonds and other assets, with a focus on a specific investment objective. Pooling your money with a group of investors lets you invest in opportunities that would otherwise be out of reach and diversify your risk. There are many different types of managed funds, with different risk profiles and investment approaches, including single sector or multi sector funds or index funds.
Review your investments regularly
It’s important to keep an eye on your investments to make sure your portfolio is balanced and you’re on track to meeting your financial goals. If you invest in a managed fund, you may only need to review it once a year. If you are investing directly, you’ll need to monitor market changes much more frequently.
It’s also worth getting advice from a financial adviser before you change your investment allocation, as selling assets may result in a tax liability. They can also give you an independent perspective on your investment goals and risk profile.
Source: Colonial First State