Showing posts with label asset class. Show all posts
Showing posts with label asset class. Show all posts

Wednesday 6 October 2010

A punt on the money

By Paul Clitheroe,
Money Magazine, September 2007

Six of the best
1. Invest in something you understand
In both life and investing, the simple things are often the best. Most successful companies have a fundamentally simple product.

It's not terribly hard to get a good grasp of how a business like, say, Woolworths works. I think a pretty good test of whether an investment is complicated and, more to the point, if you understand it, is how well you can explain it to someone else. As the famous investor Warren Buffett has said, "If you don't understand it, don't buy it."

2. Consider mainstream assets first
Most mainstream investments fall into one of three categories: cash (which includes fixed-interest securities), property and shares.

These three investment classes are generally a more proven way of generating wealth. Broadly speaking, they can be classified as income investments (cash and interest-bearing securities) and growth investments (property and shares).

Managed investment funds, strictly speaking, are not a separate asset class. They pool their unit holders' funds and invest the money in other underlying assets, such as cash, property or shares. We'll look at these two main types: "income" assets and "growth" assets.

Income assets
Income assets, also known as "conservative" assets, are generally lower in risk. They include term deposits, cash management trusts and other interest-bearing securities and they usually pay investors a specified income on a regular basis.

However, there are downsides. In keeping with the classic investment principle that risk equals return, the lower-risk nature of most income assets means their average returns are normally lower than the average returns from higher-risk growth assets, such as shares and property.

Another important characteristic of income assets is the way they are taxed. To put it simply, your income asset's earnings are taxed fully at your marginal rate (the highest rate of tax you pay). Growth assets — shares and property — attract some tax relief.

Finally there are the matters of capital growth and inflation. Assuming you hold your income assets until maturity, they offer no capital growth and are also subject to erosion by inflation. Despite these negatives, income assets offer security and regular income and therefore have a place in most investment portfolios.

Some income assets, most notably debentures used to finance property developments, are very high-risk, despite presenting themselves as low-risk. There have been serious company failures in this area with investors losing a lot of money, such as the collapse of Fincorp in 2007, Westpoint in 2006 and, in 1990, Estate Mortgage and the Pyramid Building Society.

Growth assets
Growth assets include property, shares, both international and Australian, and units in managed funds that invest in these assets.

These investments offer ongoing income in the form of rent, dividends and distributions, but they also offer capital growth and some tax breaks. It's important to remember that these investments carry more risk.

The capital growth is by no means guaranteed and while there will be periods when the market goes gangbusters (a "bull'" market), there will also be periods when the market dips (a "bear" market).

You need to be able to withstand a fall in the value of your investment.

Shares and property can also be good sources of ongoing income and, unlike income assets, the return on growth assets can be more tax-effective.

Dividends offer franking credits to offset the income tax you pay and property can give you depreciation and other allowances that can be claimed as a tax deduction. An important point to bear in mind about growth assets is that their stated returns usually include both capital growth and ongoing income, but the capital growth is only accessible if you sell the asset.

Property
Aim for the best-located real estate your money can buy. I reckon it's important to pick a property and a location that will appeal to the ageing baby boomers who make up an increasing proportion of our population.

As the population ages, the baby boomers (people born between 1945 and the mid-1960s) will increasingly move from their homes in the suburbs to smaller dwellings, such as townhouses, closer to the city or to coastal retirement enclaves.

Generally, the dwellings will need to be low-maintenance with little or no garden, made of good-quality materials, well positioned and close to all amenities. Something that fits those parameters is more likely to show stronger price and rental growth than other types of properties.

Shares
In addition to monitoring a share's performance on the Australian Stock Exchange (ASX), things you should look for in a publicly listed company include:

* whether or not the underlying business is a good one;
* whether the management team is experienced, with a good track record;
* whether the product has good growth potential.

A company's annual report provides a lot of information but can be a bit overwhelming — sometimes running to a few hundred pages. This is when the advice of a competent financial planner can be useful. Alternatively, the ASX runs courses designed to give investors a better understanding of shares (13 12 79 or www.asx.com.au).

3. Risk equals return
Taking excessive risk in looking for a big return is the number-one reason investors lose their money. They get too greedy — and investment salespeople know this. Now, I'm not saying risk is to be avoided. If you take no risk, you get no return. Everything has some risk, but you must be aware of risk. The real trick is to consider how much risk you can manage and to invest accordingly.

A young person just entering the workforce, for example, may be prepared to invest heavily in an international managed share fund. Sure, this is risky and international markets have copped a hiding over the past few years. However, with a 20-year view, this strategy could give our young investor the highest return over the decades.

At my age (51 as I write this seventh edition), I would not invest all my money in international share markets because of the high risk. However, I have been more than willing to invest some of my super money in this area — because I won't be touching it for a few years yet. Having paid off my mortgage, my main plan at this stage is to build up my super and a portfolio of other investments, such as Australian shares and some investment property. As I age, my attitude to risk will change. I'll be more concerned with protecting my wealth, not growing it, so I will gradually switch to lower-risk investments such as cash, fixed interest and blue-chip shares.

4. Invest on merit
It could be a free music CD if you buy units in a particular managed fund, a bonus deposit for opening a new savings account, even a year's worth of home insurance for taking out a new home loan. These offers may be all above board, but in some cases they may encourage investors to choose a long-term investment vehicle based on a short-term gain. It pays to stay focused on the fundamentals.

When it comes to investing, don't be baffled by big talk, broad statements or bad gimmicks. Focus on the important stuff — what the company aims to achieve, what it invests in, who runs it, what the fees are and what its long-term performance has been.

5. Diversify
In broad terms, I recommend you have a plan to create three pools of wealth — your home, your superannuation and other investments. This strategy gives you exposure to property (your home), shares and fixed interest (through your super) and other investments you buy yourself. It also gives you diversification from a taxation and legislative perspective.

Super is a highly regulated area and the main reason I would not rely solely on super is another type of risk — the risk of the legislation changing, (and it has changed a great deal). How you diversify depends upon your age, income, family and so on. For example, with a share portfolio, you should diversify by choosing different sectors within the market. You might invest in the following areas:

* Banking and finance
* Building and construction
* Media
* Health
* Resources

Inside, say, the banking and finance sector, you might further diversify by choosing several shares such as Westpac, National Australia Bank and a smaller bank, such as St George.

6. Don't try to 'time' the market
Good market timing is all about buying at the bottom and selling at the top and being a "market timer" means trying to do just that. But no market timer I know consistently gets their timing right year after year, as no one has yet worked out how to read the future.

I'm not saying you shouldn't use research to guide you to better investment areas. But when it comes down to it, determining how much risk you can live with and then buying investments that suit your risk profile and monitoring these is a better strategy than regularly switching from one investment area to another.

For the complete story see Money Magazine's September 2007 issue.

http://money.ninemsn.com.au/article.aspx?id=294907

Key points
"If you don't understand it, don't buy it."
Income assets, also known as "conservative" assets, are generally lower in risk
Dividends offer franking credits to offset the income tax you pay

Tuesday 17 August 2010

Your best Investment Method

What is Your best Investment Method?

Stocks Market
Bonds
Gold
Forex
Real Estates
Gold and Stocks Market
Stock and Bond
All of the Above!
None

Tuesday 2 February 2010

Reviewing the basics of investing in equities

Although investing in equities is risky, it is a sure way to beat inflation - especially if
  • you are patient and
  • have a long time horizon.

Five important don'ts when you want to buy shares

Mistakes to avoid when you invest in equities

Do not buy on tips or rumours.  Consult someone who has long experience of equity investment.

Do not buy with borrowed money.

Do not buy shares in boom times when everybody is buying and sell in bust times when everybody is selling.  Or put differently:  do not buy when shares are at a high and sell when they are at a low - you will make a loss!

Do not invest in a share that has been in the spotlight recently - the price might already have been driven up significantly.

Do not buy a share just because the price has dropped substantially and you think it is a bargain.  There might be sound reasons why it has dropped.

Two important strategies to help you avoid large losses: STOP LOSSES and REBALANCING

Stop losses and rebalancing are strategies to help you avoid large losses when you invest in equities.

Stop-loss strategy

A stop loss is a specified minimum price at which you will sell a particular share in order to stop the loss.  This is a good strategy with which to protect yourself against large capital losses.  You decide on a percentage loss that you are prepared to take on your investment, and sell when it reaches that percentage.  Stop losses are implemented when the buying of shares (normally not unit trusts) takes place, i.e. an instruction is given by the investor to the stockbroker to buy 1000 shares in XYZ at, say $10,00 and to implement a stop loss at, say $9,00 (the investor perceives XYZ to be a somewhat risky proposition).  The investor has done his sums and comes to the conclusion that the maximum loss he can bear is $1000, hence he limits his potential losses to $1000 by implementing a stop-loss strategy ($1000 divided by 1000 shares = $1.00 per share; $10.00 per share - $1.00 per share = a stop-loss level of $9.00)


Rebalancing

This strategy is best explained by an example.  Following the analysis of your investment profile (time horizon, risk tolerance, and investment objectives), you decide to invest 50% of an amount of $1000 in equities and 50% in other asset classes, such as bonds and cash.

Assume that after a year your equities have decreased to $400 and your other investmens have increased to $800.  This means your original $1000 portfolio is now worth $1200.

Rebalancing means that you adjust your portfolio constituents to get back to a point where half is again invested in equities and half in bonds and cash.  You will therefore have to sell some bonds and buy some equities.  This is an important strategy to keep your portfolio diversified and in line with your time horizon, risk appetite and investment objectives.

Costs of a standard equity transaction

The cost of a standard equity transaction is made up of:
  • a stockbrokers's fee,
  • taxes,
  • a levy for the adminsitrative cost of the electronic settlement system,
  • insider trading levy and
  • other compulsory administrative charges.

Brokerage

Your broker could charge you a percentage of the value of your trade, depending on the size of the trade and the nature of the service required.
  • All brokers charge a minimum per deal, even if your order is very small.
  • If your investment is too small, the charges could dilute your returns considerably.  Your investment would need to deliver sizeable returns before expenses are recovered. 

The stock market provides a market for setting prices based on supply and demand

More about the stock market

The stock market provides a market for dealing in listed shares, and for setting prices based on supply and demand.

It is for this reason that prices of equities fluctuate.

Just as in any open market, prices will go up if there are more buyers than sellers and vice versa.

Most of the buying and selling occurs electronically today.

The performance of the stock market is often gauged by the performance of an important index.  An index reflects the performance of a grouping of shares. 

The best known index in the world is the Morgan Stanley Capital Internation (MSCI) Index, which represents the biggest shares in the world based on market capitalization.  When the prices of these shares dip, the index will also go down, and vice versa.

For each country, the main index consists of the biggest shares based on market capitalization.  There are also other sub-indices (financials, industrials, mining, etc.).  Each of these indices represents a certain grouping of shares based on their market capitalisation.

Listed and Unlisted companies.

You can hold shares in companies that are
  • listed on the stock market or
  • in unlisted companies. 
The bulk of equity investments are in listed shares. 
  • Companies list on a stock exchange in order to gain access to more capital, and
  • they must comply with stringent criteria set by the stock exchange to protect investors.

Be very careful when you invest in unlisted shares. 
  • Unlike the listed companies, the unlisted companies are not scrutinised that closely. 
  • Shares in unlisted companies therefore carry a bigger risk and
  • are also much more difficult to sell as there is no open market.

Inflation is your ultimate enemy. Your other enemy: IMPATIENCE

Inflation is your ultimate enemy.  But impatience can be an even worse enemy when it comes to equity investing.

The important thing when you invest in equities is time.

Over the long term - 10, 20, 30 years of longer - equities offer you the best chance to generate returns that will beat inflation. 

To buy equities only to keep them for a short while is a guaranteed recipe for failure.

You therefore have to be aware of
  • your time horizon and
  • your risk appetite
when you decide to invest in equities.

You should be aware that huge fluctuations can occur and that the portion of your equity holdings should decrease the closer you get to retirement.

Equities carry the highest risk. Why, then, invest in equities?

You can also make a lot of money investing in equities.

During the long term, US stocks gave a historical compound annual return of 11% to its investors.  During the period January 1960 to December 2000, you could have earned a compound after tax return of 16.9% a year on your shares on the South African stock market.

Equities are one of the few asset classes that give you a real chance to fight inflation over the longer term.

The reason for this lies in the nature of equities.  Equities are investments that give you part-ownership in a company.

Companies issue shares because they need money (or capital) to expand. 
  • When you buy shares, you own part of the company, including its assets. 
  • That explains why, although the value of money decreases with inflation, your investment in a good company can increase as the company grows and the value of its assets increases. 

Note that we say a 'good' company
  • Not all companies are good companies and not all share prices will increase over time, simply because not all companies will expand and grow. 
  • That is why it is important to be clever when you make equity investments.

Besides your share in a company's capital (i.e. its assets less its liabilities), you can also share in its profits by way of dividend payments to the company's shareholders.  This is another reason why investment in equities provides one of the few opportunities to safeguard the REAL VALUE of your capital.  The term 'real' is very important in investment terminology.  It means that you have taken the impact of inflation into account.

The risk involved in equities

You can lose a lot of money investing in equities. 

That is why it is the asset class carrying the highest risk. 

If you had bought shares during the height of the Internet boom in March 2000, you would have lost 72% if you had sold them 18 months later!

Equities are affected by many risks, including:
  • commercial risk, for example, interest rate changes and trade cycles
  • political risk, for example, negative sentiment about Third World countries
  • market risk, for example buying shares at the top (when they are too expensive) and selling them at the bottom (just before prices start to increase again).
Anyone who has invested in equities over the past few years knows how it feels to be on a roller-coaster ride. 
  • In the end of the last century, investors witnessed huge stock market crashes (in 1987, and again in 1998), interspersed with a spectacular rise in share prices as investors started to become hyped-up about the new economy and Internet stocks. 
  • Then, of course, a major downswing was experienced in September 2001 after terrorist attack in the USA. 
  • Due to low interest environment for many years following 911, the US stock market crashed in 2008 due to the subprime credit crunch.

Sunday 31 January 2010

Reviewing the basics of interest-bearing investments

To have a good understanding of interest-bearing investments, learn and know the followings.

The risks of interest-bearing investments, for example:
  • inflation,
  • interest rate cycles and
  • dubious borrowers with poor credit ratings.

The advantages of investing in this asset class, particularly
  • the interest income on which you can rely.

Some of the main interest-bearing investments in the market.  These include: 
  • cash,
  • money market funds,
  • bonds,
  • participation mortgage bonds and
  • voluntary purchased term annuities.

You have to know about two new market places other than the stock market: 
  • the money market, where short-term interest-bearing secuities are traded, and
  • the bond market, where longer-term interest-bearing securites such as bonds are traded.

Mistakes to avoid when investing in interest-bearing instruments

Interest-bearing investments may be relatively stress-free, but they too have their pitfalls.  Watch out for the following:

  • Do not accept the first interest rate you are offered.  Compare interest rates, negotiate where possible and find out more about fixed versus fluctuating interest rates and the term of fixed-interest investments.
  • Do not think interest-bearing investments are safe, risk-free havens.  Remember the impact of inflation.
  • Do not forget about interest rate risk.  When interest rates increase, bond prices will decrease, resulting in a loss on your investment.  The longer the term of the bonds, the greater the drop in the market price.
  • Do not invest in bonds without understanding the terms of the bonds and the interest rate environment.  Invest in well-known and reputable bonds rather than in unknown corporate bonds.

Other interesting interest-bearing investments: Mortgage Bonds and Term Annuities

Today a myriad of unit trusts invest in interest-bearing investments.  These include:
  • money market funds,
  • income funds, and,
  • bond funds.

Mortgage Bonds

One of the most attractive interest-bearing investments with a fixed capital value is participation mortgage bonds. 
  • Here you invest in units in large mortgage loans that are granted against the security of a first-class physical asset, for example, commercial, industrial or other property. 
  • Your capital is guaranteed and you earn interest at a competitive rate that can be variable or fixed. 
  • A great advantge is that a participation bond becomes quite liquid after the initial five-year period when you can still enjoy the interest income and withdraw on only three months' notice.
  • (These mortgage bonds caused the subprime credit crisis in 2007-2008 in US).

Term Annuity

A voluntary purchased term annuity is another important investment product from which you can earn a regular income.  It is simply the exchange of a cash lump sum for income, which is paid annually, half-yearly, quarterly or in monthly instalments over a specified period (minimum five years). 
  • This basically means that your original capital is refunded by way of regular instalments together with interest earned on the investment. 
  • You will therefore not get back any capital at the end of the period as in the case of fixed deposit. 
  • A voluntary term annuity can be purchased at any life office and is in essence an insurance contract. 
  • The interest or annuity rate is fixed for the term of the contract, but varies from institution to institution. 
  • This investment product also offers a tax benefit, as you pay tax only on the interest part of your annuity.

More about another interest bearing investments: bonds

Bonds are fixed-income securities that governments and companies issue in order to borrow money.  They pay interest to you for that privilege. 

The maturity date is the date on which the full amount that was borrowed is returned to you .

The investment term is normally a fairly long period, say ten years or longer.

The coupon is the interest rate you receive

Bonds are traded on the capital market in the same way that equities are traded on the stock market.

Bonds are medium-risk investments because the interest rate cycle has a definite impact on the value of bonds. 

If you want to understand bonds, this is the most important thing to remember:  when interest rates fall, bond prices rise; when interest rates rise, bond prices fall. 

This is simply because the coupon on the bond is fixed, and the market value of the bond is adjusted to bring the coupon in line with the external interest rate. 

Bonds are a very important part of a well-diversified portfolio.  In difficult stock markets, bonds can provide a cushion to soften the blow.

Money market funds have become very popular alternative to bank deposit

A money market fund is a type of unit trust that invests in interest-bearing instruments issued by banks, government and companies when they want to borrow money.

These short-term instruments are
  • traded on the money market, and
  • have a maturity of less than 12 months.

Money market funds have major advantages in comparison with other cash investments.  For example:
  • You gain access to money market instruments even though you invest only a small amount.
  • The interest rate is higher than for a bank deposit, as you are part of a group that can bargain for the best wholesale rates.
  • You can withdraw your money at any time, like a call deposit at a bank.
  • Interest rate risk is largely eliminated because money market funds are allowed to invest only in instruments with an average term of not more than 90 days.
Units in a money market fund have a fixed value of $1, and the only changing aspect is the interest income an investor earns on that unit.

This income is capitalised, or reinvested, which means the investor earns interest on interest.

Money market funds are ideal
  • for pensioners who must live on their interest income or
  • for the creation of an emergency fund from which you can withdraw money at any time. 
Money market funds also provide useful parking for investors
  • to limit the risk of an investment portfolio in uncertain times or
  • to phase in their funds.

When you invest in a money market acount, you should know the difference between the nominal and effective rate. 
  • The effective rate is the interest rate you will earn if your money is deposited for the whole year and all the interest is reinvested. 
  • The nominal rate is lower because this is the rate you earn every month before any reinvestment of interest is taken into account.

The 'safe' option of cash

Cash has always been seen as a fairly safe investment, and our forefathers were quite happy to put their money under the mattress and leave it there.

Today we realise that you cannot just put your money away and forget about it, because inflation will erode its value.

If you want a stable income, a bank deposit is still a valuable investment option.

However, money market funds have become a very popular alternative.