4CRB: Investment Basics

Have you ever thought about investing but don’t know where to start? Do you understand or get confused by industry jargon? Do you know the difference between the asset classes you can invest in?

If you answered “yes” to any of these then today’s show is a must listen for you. 

In today’s session we’re going to go back to investment basics and give you an understanding of the different ways that you can invest and some of the risks, tips and traps to be aware of. 

Our review will start with the more conservative style assets leading to more growth style assets.

Cash & Term Deposits

No doubt you would be familiar with putting your money in an account with a bank or if you wanted to earn a higher interest rate you would invest via a term deposit for a fixed term.

Things to be aware of when you invest via this asset class:

• With cash style investments you will not see any growth in the value of your starting deposit.  You will own receive income in the form of interest paid;
• There is generally very little risk with investing in cash or term deposits;
• Not all fixed term providers are the same.  We would generally advise to stick to the names you know; 
• Term deposits will have a different rating depending on the issuer. Not all banks and institutions are the same;
• There are different terms of maturity for your TD’s and you should question is the interest paid monthly or at maturity?  You should also ask what the exit fee is should you need to withdraw your funds before maturity; 
• The 6 month term tends to be the most competitive timeframe but do your homework and research the different rates available depending on how long you don’t need to access these funds;
• Some high interest rate savers can actually pay more than a term deposit that pays the interest at maturity.  Some have traps like you have to make a deposit or you are not allowed to take a withdrawal to receive the higher interest rate.
• There is the Government guarantee known as the Financial Claims Scheme which provides protection to depositors of up to $250,000 per account-holder per authorised deposit-taking institution (ADI) (bank, building society or credit union) in the event of the ADI failing. For joint accounts, each account holder is entitled to the $250,000 guarantee;
• Beware of Mortgage funds that are trying to look like term deposits. They are not the same thing. They do not have the same risks.

Fixed Income

Investing in fixed interest securities can be a prudent strategy for investors seeking stability and predictable returns. Fixed interest instruments, such as bonds and certificates of deposit, offer a predetermined interest rate over a specified period, providing investors with a reliable income stream. One of the key advantages of fixed interest investments is their lower risk compared to equities, making them an attractive option for conservative investors or those nearing retirement.

These investments are characterized by their fixed coupon payments, providing a sense of security and predictability. Bonds, for instance, pay periodic interest and return the principal amount at maturity, offering a predefined cash flow. This can be particularly beneficial for those looking to preserve capital or generate steady income.

Additionally, fixed interest investments can act as a hedge against market volatility. While equity markets may experience fluctuations, fixed interest securities offer a more stable and predictable performance, serving as a counterbalance in a well-diversified portfolio.

Investors should carefully assess their risk tolerance, financial goals, and time horizon before incorporating fixed interest securities into their investment strategy. While these instruments may not offer the same potential for high returns as riskier assets, they play a crucial role in providing stability and income, contributing to a well-rounded and resilient investment portfolio.

The Rise of Fixed Income

We feel that this asset sector is representing good value at the moment. With higher interest rates the return from these assets are looking more attractive compared with your typical cash style investments.   YOU NEED TO BE AWARE THAT THE CAPITAL VALUE OF THE FIXED INCOME INVESTMENT WILL MOVE WITH INTEREST RATE CYCLE.

There are three main types of fixed income style investments that you will typically see used in Australia.  These are:

• Government Bonds
• Corporate Bonds
• Hybrids

What is a bond?

A corporate Bond is a bond issued by a corporation order to raise financing for a variety of reasons such as ongoing operations, mergers & acquisitions, or to expand a business. The term is usually applied to longer term debt instruments, with a maturity of at least one year.

A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments, and to repay the face value on maturity. (Wikipedia)

How to access

You can buy them directly via an issuer or from the Australian Share Exchange (ASX) or you can invest via a Managed Fund or an Exchange Traded Fund (ETF).

Tips for fixed income investing:

• Not all fixed income is the same. Make sure you know what you are investing in.
• Is it a fixed rate or floating rate?
• What is the average rating of the underlying investments?
• What is the average term to maturity?

Traps

• Use caution to know what you’re investing in.  Look under the bonnet as all bonds are not investing into the same thing;
• Bonds have different risk characteristics to be aware of;
• A good rule of thumb is the higher the income rate then generally the higher the risk associated with them;
• When interest rates are at or near their peak, fixed income can be more attractive and when interest rates are low and increasing they are generally less attractive;
• A fund needs to revalue the underlying investments daily, this can work for you or against you.

Property

Bricks and Mortar investing has been popular in Australia for many, many years and this is generally because investors feel comfortable knowing that they have a tangible asset that they can see and touch.  There are many different ways that you can invest in property, not just your typical investment property.  The income that you receive from a property investment is the rental income and the growth that you receive is from the property value appreciating. 

You can buy a property yourself whether that be for residential purposes or an investment property.  You can invest in a property fund or buy a listed property ETF online?

When considering property as an investment asset you need then assess whether you should invest in a commercial or residential property. 

Commercial property tends to have a higher yield. The tenants tend to be longer term. There is less ongoing maintenance. Whereas, residential property tends to have a higher capital gain over time but tenants can turn over more and there is generally a higher upkeep.

Unlisted Property Trusts have the problem of the lack of liquidity.  If you need some of your money back you may not be able to get it.  Investing into Unlisted Property Trusts should only be for long term funds that you do not need back. Listed property trusts on the other hand tend to be more liquid.

Property investments can be lucrative but there are also risks associated with this style of investment.  Following are some tips and traps for “bricks and mortar” property investments:

• Research: Understand the local real estate market, property trends, and potential areas for growth or stability;
• Financial Planning: Calculate your budget, deposit needed, mortgage payments, taxes, maintenance costs, insurance and rates and potential income from rent;
• Location: Choose properties in desirable locations with good amenities, transportation links, and potential for capital appreciation;
• Inspect Thoroughly: Conduct a detailed inspection to identify any issues or repairs needed before purchasing;
• Long-Term Perspective: Real estate investments often appreciate over time, so be prepared for long-term commitment rather than expecting quick returns;
• Professional Advice: Consult with real estate agents, financial advisors, and legal experts to guide your investment decisions and understand local regulations;
• Stay Informed: Keep up-to-date with market trends, economic indicators, and changes in regulations that may affect your investments;

Property Traps:

• Over-leveraging: Borrowing too much can lead to financial strain, especially if rental income doesn’t cover expenses;
• Market fluctuations: Property values can fluctuate, impacting investment returns;
• Maintenance costs: Unexpected repairs or maintenance can eat into profits;
• Vacancy risk: Rental properties can sit empty, resulting in loss of income;
• Lack of diversification: Putting all your money into property can leave you vulnerable to market changes;
• Regulatory changes: Tax laws and regulations can affect profitability;
• Illiquidity: Selling property can take time and may not be possible when needed.  You also can’t just sell of a piece of the property if you need a smaller lump sum;
• Location risk: Properties in declining areas may not appreciate or generate rental income;
• Management challenges: Being a landlord requires time, effort, and dealing with tenants can be demanding;
• Interest rate changes: Rising interest rates can increase mortgage payments, affecting cash flow.

If bricks and mortar aren’t your thing but you would still like exposure to property investments, then speak with a financial planner around unlisted or listed property trusts as an alternative to gain a better understanding of this style of investing to determine if it is appropriate for you. 

RFS Advice Approach to Property

At RFS Advice, it is generally our preference for clients to buy the best principal place of residency that they can afford. This can also have some taxation benefits in the capital gain.

We prefer our clients to access a property investment directly and help them control their cashflow. If we are to allocate funds to property for clients as part of the portfolio we manage, we believe it must be liquid. 

Direct Shares

What is direct share investing?

Direct share investing refers to the practice of buying and owning individual shares directly from a company or through a brokerage account. This approach allows investors to choose specific companies they believe will perform well and potentially generate higher returns.  You earn income from direct shares via dividends that are paid to the shareholder/investor and the growth you receive is from the capital appreciation of the share value increasing.  Direct share investing can be more profitable over time compared with other styles of investing, but like all kinds of investing there are risks associated and the risks with direct shares can be considered higher due to their volatile nature. 

How to invest in shares

There are several options on how to access the share market.  You can:

• Buy the share directly. This could be done yourself via a platform that allows you to trade on the ASX;
• You could pay a broker to do this work for you in an effort to have a better performance;
• You could invest via a managed fund;
• You can invest via an ETF;
• There are now low cost ETF platforms allowing you to access their ETF’s as a self-directed model;
• You could seek advice from a financial adviser.

Tips:

• Do your research and make sure you know what you are buying.  What is the history of the company, what is its financial position, what are the risks with this company, do they pay regular dividends etc?
• You need to know the costs involved;
• You need to know how they are performing relative to peers;
• Ensure you diversify between different companies to reduce the impact of any single share’s performance on your overall portfolio.  Diversification helps mitigate risks;
• Due to the potential volatility associated with direct share investing it is important to have a long term approach and set realistic expectations: Understand that investing in shares involves volatility and fluctuations in share prices. Set realistic expectations about returns and be prepared for short-term market downturns. Avoid making impulsive decisions based on short-term market movements.

Traps associated with direct share investing:

• Market Risk: This is the risk of losses due to movements in the overall share market. Factors such as economic conditions, geopolitical events, and market sentiment can cause fluctuations in share prices.
• Company-Specific Risk: Individual companies may face risks unique to their operations, such as management issues, competitive pressures, legal or regulatory challenges, and changes in consumer preferences. Poor company performance can lead to a decline in share prices.
• Volatility Risk: Shares can be subject to significant price fluctuations over short periods, leading to volatility in their value. Higher volatility increases the potential for both gains and losses.
• Interest Rate Risk: Changes in interest rates can affect share prices. For example, rising interest rates may increase borrowing costs for companies, potentially reducing their profitability and share prices.
• Political and Regulatory Risk: Political instability, changes in government policies, and regulatory developments can affect the performance of shares, particularly in industries sensitive to government actions such as healthcare, energy, and financial services.
• Systemic Risk: This is the risk of a widespread disruption in the financial system, such as a financial crisis or market crash, which can affect the value of all investments, regardless of their individual characteristics.
• Timing Risk: The timing of your investment decisions can impact returns. Buying shares at peak prices or selling at lows can result in losses. Additionally, trying to time the market can be challenging and may lead to missed opportunities or increased trading costs.
• Diversification Risk: Investing into just the one company can result in diversification risk as you are effectively placing all your eggs in one basket.  When an investor’s portfolio is not adequately diversified, meaning it’s heavily concentrated in a few assets or within a particular sector, the investor becomes more vulnerable to diversification risk. If adverse events occur that impact those specific assets or sectors, the investor may suffer significant losses.

It’s essential for investors to carefully assess these risks and consider their own risk tolerance, investment goals, and time horizon before engaging in direct share investing.

Australian versus International Shares

When considering investing into direct shares, you also need to weigh up whether you will invest into Australian shares, international shares or both and also, how do you invest this way?  Do you invest directly or will you invest via a managed fund or ETF. 

Other points to assess:

• What allocation will you have between these options?
• Australian shares will have franking credits but international shares will provide exposure to companies that you cannot access in Australia which could provide you with more growth opportunities.
• There are blue chip larger companies and smaller higher growth companies. What is the correct mix between these?

The more you ask question you can end in more confusion! This is where a financial adviser can assist you. 

Different Ways to Invest in Shares

Value Investing

A value manager is a professional fund manager or investor who follows a value investing strategy. Value managers seek to identify undervalued securities in the financial markets. They analyze individual shares, bonds, or other assets to assess whether their intrinsic value is higher than their market price. This approach often involves scrutinizing fundamental factors, such as earnings, dividends, and financial health, to determine a security’s true worth. By investing in assets believed to be trading below their intrinsic value, value managers aim to capitalize on potential price corrections and long-term appreciation, aligning with the principles of value investing pioneered by investors like Warren Buffett.

Smart Beta or factor Based Investing

Factor-based investing involves constructing an investment portfolio based on specific attributes or factors that historically have been associated with higher returns. Common factors include value, momentum, size, quality, and low volatility. Investors leverage these factors to gain a more targeted exposure to market dynamics and potential sources of risk and return. For example, a value factor strategy might involve selecting securities that appear undervalued based on metrics like price-to-earnings ratios.

Factor-based investing is rooted in the belief that certain characteristics drive asset performance, and by emphasizing these factors, investors can enhance their portfolio’s risk-adjusted returns.  Quantitative models and data analysis play a crucial role in identifying and implementing factor-based strategies. While it offers a systematic approach to investing, success depends on understanding the chosen factors, their historical behaviour, and their relevance to current market conditions. Investors often use factor-based strategies to enhance diversification and capture specific market anomalies or trends.

Index Based Investing

Index-based investing in shares involves constructing a portfolio that replicates the performance of a specific market index, such as the S&P 500 or ASX 200. Instead of actively selecting individual shares, investors allocate capital to mirror the proportions of the index constituents. Exchange-traded funds (ETFs) and index funds are common vehicles for index-based investing, offering diversification across a broad market segment.

This strategy leverages the concept that the overall market tends to appreciate over time, and by tracking an index, investors can capture the market’s general performance. Index-based investing is often associated with lower costs compared to active management, as it requires less research and trading activity. Additionally, it provides transparency, as investors know the index’s composition and can assess its historical performance.

It is a popular choice for investors seeking broad market exposure, long-term growth, and a passive investment approach.

Growth Investing

A growth manager in shares is an investment professional or strategy focused on identifying and investing in shares with the potential for substantial capital appreciation. Growth managers seek companies that are expected to experience above-average revenue and earnings growth, often prioritizing businesses in the early stages of expansion or operating in industries with high growth potential. These managers typically assess a company’s growth prospects based on factors such as product innovation, market share, and overall industry trends.

The investment philosophy of growth managers often involves a willingness to pay premium valuations for shares, as they believe the strong growth trajectory justifies the higher prices. This approach contrasts with value investing, where the emphasis is on finding undervalued shares.

Growth managers may engage in active research and analysis to identify companies with promising growth characteristics, making strategic investment decisions to build portfolios that align with their growth-oriented objectives. The goal is to outperform the broader market by capitalizing on the potential for robust earnings and share price appreciation among selected growth shares.

RFS Advice Approach or Philosophy to shares:

Our philosophy at RFS Advice believes in equal weighting both Australian and international shares and equal weighting in different styles.

We know there are benefits of rebalancing a client’s portfolio back to the original benchmarks that were set at least on a quarterly basis. 

Only professional, reputable managers are used in our client’s portfolio’s as they have the experience and history to successfully run a portfolio. 

We use our beliefs and buying power now of over $1 billion to drive down the costs of professional managers and pass these savings directly back to the investors.

Summary:

As we have seen in today’s show, there are many different ways to invest, all with their own risks, disadvantages, positives and negatives. 

Some investors like to manage their investments themselves; others want to partner with an advice firm to help their family through this journey.

If all of these options sound overwhelming and too hard then come and see our team and let us help you identify what is the best outcome for you and your household based on your own personal circumstances.

At RFS Advice we believe in tailored advice and providing advice that is personalised for you.  We are here to help.

Ask Troy a Question.

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As always, when considering investing it is important to seek advice to ensure that the investment asset you choose is appropriate for you.  The information provided in today’s show is prepared on a general advice basis only and should not be relied upon.  The information included here has not taken into account your personal circumstances, objectives or needs and we recommend that you seek personal financial advice before making an investment decision.