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 might you begin?
Almost every type of investment come with risk
Investments can help grow your money. However, there’s not only a risk associated with the various investment types, there’s also a risk you could lose money, as well as the possibility that your investments won’t achieve your financial goals within the timeframe you set out. Generally speaking, the higher the risk, the greater the potential return over the long term.
Understand your risk profile and timeframe
With this in mind, it can help to first understand what type of investor you are – and recognise that this may change as your life changes or as you get closer to retirement. To work out your risk profile, think about how you feel about short-term fluctuations in the value of your investments. Would they keep you awake at night, or would you be comfortable riding them out?
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 ‘moderate’, ‘growth’ or even ‘high growth’ end of the risk spectrum. But if you’re planning to retire or scale back on paid work soon, you may adopt a more ‘defensive’ or ‘conservative’ investment approach to protect the value of the capital you’ve built up.
A market correction close to retirement could have a disproportionate impact on a portfolio – so it’s worth considering two risk profiles: one for superannuation and one for other investments.
What are asset classes?
Cash is considered one of the safest investments. But in exchange for its safety, it also generally offers the lowest potential return. Investing in a cash option can provide stable, low-risk income – usually through interest payments.
Investments in government or corporate bonds, mortgages or hybrid securities are a loan by you (the investor) to the issuer. In return, the issuer pays you a regular interest payment over a fixed term. Depending on the kind of investment, they can also repay the capital you initially loaned them at the end of the term.
Property and Infrastructure securities
You can invest in property and infrastructure via the share market – including commercial, retail and industrial property, or transport, utilities and telecommunications infrastructure. Investing in property and infrastructure securities can help you access these investments without needing the often large sums of capital required for owning them directly. The potential returns for these investments can be medium to high, but you may need to hold them for a few years.
Australian and International shares
Shares (also known as equities) give you part-ownership of an Australian or international company. Your potential returns include capital growth (or loss) and income through dividends. Shares are considered medium to high-growth assets whose values tend to trend higher over time.
However, they generally carry a higher level of risk than other asset classes, meaning you may need to hold them for longer than other assets to ride out market fluctuations and generate higher returns.
All about diversification
All investments perform differently when financial markets change. Diversification is when you spread your investments across a range of assets to help reduce risk in your portfolio – that is, to avoid putting all your eggs in one basket.
Diversification won’t fully protect you against loss, but it can help reduce your risk of capital loss if there is a market downturn – balancing out your returns if some investments underperform others in a given environment.
Source: Colonial First State