Plummeting interest rates have decimated savings accounts, and money-smart Australians are increasingly looking for new ways to make a bit of extra cash.
While investing spare cash (including tax returns) might seem like an obvious choice, what’s less obvious is how to plan those investments and make sure they do what they’re supposed to do, and more importantly to pick investments that will achieve that purpose.
The decisions behind what kind of assets to buy are much more difficult than the decision to invest, but Industry Fund Services head of technical, research and advice services Craig Sankey said it becomes much easier once it’s broken down into four key steps.
1. Defining your objective
It’s easy to say ‘I want more money’, but different investment strategies generate money in different ways, and picking the right one means knowing exactly why, and when, you need that additional cash-flow.
Someone looking to save up a bit of extra dosh for a holiday will have a shorter investment timeframe than someone looking to build their wealth to buy an investment property in five or 10 years time.
Investors need to identify exactly why they need money, how much they need, and when they need it by before putting their cash into anything.
2. Attitude to risk
Investing is always risky, but just how risky it is will vary between investment opportunities.
Higher-risk investments will provide investors with higher rewards, provided everything goes to plan, but would-be investors need to understand just what they stand to lose and whether they can afford such a loss.
3. Work out what types of investments will suit
Once you know what your objective as an investor is, and how much risk you can afford to take, the next step is to pick an approach that will suit both of those preconditions.
It’s at this stage that investors need to think about which asset class will best suit their needs. These classes divide investment opportunities into groups based on their individual attributes.
Some, like property, can offer big capital gains but require a lot of money to be invested, can’t be easily sold (or sold in portions), and carry greater risk of loss, while others (including bonds) are safer and easier to liquidate for money, but don’t offer as large a return.
4. Picking the right products
This is where investing gets to the pointy end. Once you’ve worked out why you’re investing, how much risk you can take on, and what assets will meet your needs, the time has come to research individual investments and find ones you’re comfortable with.
Too often, Mr Sankey said, would-be investors actually start at this step, investing in a company, scheme, or product recommended by a friend without thinking about what they want to achieve.
“It’s important to go through these four steps, and to do it in order – working backwards is how people end up investing in things that don’t suit their needs and often lose money,” he said.
Mr Sankey had a few final pointers for investors, the first of which is the importance of ‘diversification’. In lay terms, Mr Sankey said it’s important not to put all your eggs in one basket, and to try putting money in different types of investments, so if one suffers a loss, the others will –hopefully – remain safe.
The table below outlines the performance of a number of asset classes each year over a ten year period, highlighting the swings between each one’s performance.
His final piece of advice?
“Never invest in anything you don’t understand,” Mr Sankey said.
“If you don’t understand what you’re investing in, you shouldn’t be investing in it; that’s where we see a lot of people get into trouble and suffer losses, which could be for fraudulent reasons or because it was inappropriate for them and they tried to get out at the wrong time.”
And, if you’re not comfortable making those decisions on your own, your best option is to seek professional advice before taking the plunge, he said.