Investing basics 102

When thinking if investing is right for you, it's important you feel comfortable understanding the basics before rushing into unfamiliar territory

Retail and SMSF Superannuation funds are one of the most common investment vehicles available today.

But how do you find an investment style that’s right for you?

Start with the essentials

By now you may have read our Investment Basics 101 and are ready to start a conversation with a financial adviser.

An adviser will usually get you to complete an investment risk appetite questionnaire and begun to think about expectations and time frames when considering whether investing is right for you.

Here are some helpful tips to consider before rushing off into unfamiliar territory.

First, determine what your risk profile is

Your risk profile is based on a number of issues but here are four basic steps to start with:

  1. Your investment timeframe, and
  2. Your tolerance for the up and down performance of the investment market.

Both share markets and housing market rise and fall, but often at different times and in response to different aspects of the economy.

Then determine what your stability profile is

  1. Your stability of employment, and
  2. The stability of your good health

Your employment and your health are both key influences that need to be taken into consideration whenever you are making longer term goals too.

The longer you have until retirement, the more time you have to ride the ups and downs of higher-growth investments, such as shares and property. But if you’re planning to retire soon, you may prefer the security of a more conservative investment but with lower growth potential.

Pro tip: Once these 4 elements have been identified, the appropriate asset allocation ( the 2 type of investment) is usually based upon time horizon first and actual risk profile second. So if you’re an aggressive investor but with o2-year investment window then the asset allocation is based on your timing, not your investment style.

Does your health support your investment plan?

Having a negative health event that stops you earning an income will usually have an impact on your being able to invest. If you have a recurring health concern, that also must be taken into account as investment decisions could potentially lock up your funds for some time (rather than keeping them liquid and ‘at call’).

Does your current personal insurance cover support your investment plan?

Make sure any income protection policy covers you until age 65 or beyond and remember that such policies only pay you up to 75% of your income (and only for as long as the policy lasts). For people with salary continuation cover provided by their super fund, such insurance policies are usually capped at a maximum of 2 years benefit payments, so you may need to ask about a 'top up' policy to ensure your covered until age 65 with your adviser. If you’re in a professional occupation where you might choose to work until age 70, make sure your income protection policy covers you as long as you intend to work.

Does your employment support your investment plan?

If your employment position is uncertain, your tax profile and capacity to continue to participate in a regular ‘invest to save’ program may also impact your investment decisions.

Client Story

“I was once brought in to help a person who was wanting to purchase a highly geared investment property. Shortly before the property settlement, she suffered a serious back injury which saw her unable to return to work, placed on indefinite sick leave and facing an uncertain future on the minimum wage from her employer's Workers Compensation Insurance. Her reduced wage also reduced her tax position (that was needed to balance the investment mortgage repayments).

Now living on a reduced income, her increasing medical and rehabilitation bills quickly absorbed any surplus funds that were previously planned to be used as a co-payment to the new investment structure. Failing to consider the stability of her future occupation and health, exposed her to the unmanageable risk of having to hold an non-liquid investment asset for an unspecified length of time or risk a fire sale where she would lose significant value and still be left with a portion of an investment commitment now serviced from a reduced income.” - Drew Browne

*The identifiers are changed but the case study is based upon a real life situation.

Does your investment plan pass the ‘sleep easy’ test?

You also need to consider how much risk you’re comfortable with in your investments. Generally speaking, the higher the potential for investment growth, the greater the risk. Higher growth investment assets are more strongly affected by market volatility, and there is no guarantee you’ll receive the level of growth you expect.

At the same time, it’s important to balance risk against the need to generate a high enough return to deliver the retirement lifestyle you’re looking forward to. You can see why investing is a more involved process than the late night infomercials would like you to believe.

Some good things to look for

Consider long-term performance over short-term speculation

The risk of running out of money in retirement is perhaps the most emotionally challenging risk of all.

When investing you may wish to look for funds that aim to consistently generate strong returns over the longer term. While it can be tempting to choose a fund that’s at the top of the performance tables today, remember that past performance is no indication of future performance, with changing market conditions often producing different results in different years.

A better approach may be to is to look at the fund’s investment philosophy and consider the opinions of research services like Morningstar, Lonsec or Cannex. Then, when you find a fund you’re interested in, read the Product Disclosure Statement to find out how your money will be invested and consider if it’s in alignment with your personal investment approach.

If you do decide to look at past returns, use the longest period available – preferably five years or more and be careful to compare like with like. After all, you can’t expect a defensive investment style fund to produce the same returns as a higher risk alternative.

Don’t keep all the eggs in one basket

Superannuation is a long-term investment, so it’s important to consider diversification alternatives rather than put ‘all your eggs in the one basket’. The governments constantly changing super laws and the failing social security system indicates that the risk of legislative risk is on the rise. What is promised in superannuation today, may not be what’s always delivered tomorrow.

Don't put all your eggs in the one basket and keep them there unless that's your plan. Put in technical speak—diversification across investment asset classes and sectors is usually a valuable way to reduce risk and smooth returns over time. Remember, that you may want to update your investment asset mix as you grow older or as your risk profile changes due the changes in your personal situation, like health, continued employability, relationships and other strategic life events.

Find value for your money

Investment management fees can make a big difference to your returns over time, so it’s important to find a fund that offers good value for money. Our experience has been that people are happy to pay a fee for a fair exchange in value. But value is about more than just the amount you pay to the investment manager to gain access to their services and infrastructure – it also depends on the service you receive in return.

If you just want your financial adviser to help get you started, be upfront with them and set the expectation early. If you understand that you would be well served to have an annual check in and review of your situation (including your investments) once a year, let them know that as well so that they can structure a proposal accordingly.

Pro Tip: Remember that a super fund is effectively like a fridge holding different types of food and beverage. Apart from the running costs, a fridge is a fridge is a fridge – they can all hold the same contents and do much the same job. So apart from running costs, it’s the types of investments they hold and the managers they use, that often creates the value. - Drew Browne