interchangeably.
After a company has completed its float and issued shares to investors, the shares can be sold to other investors on the sharemarket. This is referred to as the secondary market.
Share trading takes place through the agency of stockbrokers who enter buy and sell orders on behalf of investors.
The price of the shares is determined by the forces of supply and demand, with investors deciding what they will pay for shares in individual companies or what they will accept for shares they already own. The growth and profitability of the companies, alongside other external factors, influence these decisions.
Now that you have an understanding of the market itself and the difference between the primary and secondary market, it is time to talk about your choices when it comes to investing.
CHAPTER 3
The main investment areas: cash, fixed interest, property, shares
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.
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 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.
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
