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Author Topic:   Some investment basics
posted 08-02-2003 06:53 AM     Click Here to See the Profile for Share_market_information     Edit/Delete Message
Investment basics

The variety of investment products available can be very confusing. However, it becomes easier to understand if you think of investment products under three main categories:

* income producing investments;
* capital growth producing investments;
* investments producing both income and capital growth.

As you read on, these categories will be explained. Despite the wide variety of investment products available, they derive from three basic types of investments:

* interest bearing products
* shares property.

Before you invest in a particular product, you should think about the following investment guidelines.

1. Decide on your investment needs

Do you want your investments to earn income or capital growth?
Income producing investment products pay you a regular income. You can reinvest this money or use it to meet your daily expenses. These are generally lower risk investments. However, there is usually no capital growth, and over time the value of your investment may be reduced by inflation. In retirement, you may decide to place your money in an income stream product (see page 38). Capital growth products' value may increase or decrease due to movements in the value of the investment itself. This will be reflected by changes in the unit price. Capital growth can be converted to income by cashing in a portion of your investment. However, sometimes this can be complicated, have tax implications and incur fees. So you need to maintain detailed records of your investment transactions. Although the value of your investment has the potential to grow, capital growth products are usually higher risk investments and may best be held for at least five years.

2. Invest for the right length of time

Do you need emergency money, longer-term investment money, or perhaps both?
The investments you choose should depend on how long you want to invest your money. Money you need for short-term expenses and emergencies is best placed in more secure savings accounts. These generally produce lower returns, but you know the money will be available when you need it.

If you are prepared to invest your money for a longer term, for example more than five years, and are prepared to accept some short-term losses in exchange for expected overall long-term gains, you may want to consider growth investments.

Growth investments such as property trusts and equity trusts should not be regarded as short-term investments, no matter what the advertising may suggest.

3. Use quality investments

Do the company and its products have a reliable track record?
Wise investors aim to invest in companies with reliable reputations that have been established over time. It may be better to earn a lower return but know that your money is secure. Investing in a less reputable company may give you a higher return, but you risk losing your money.

Carefully check any guarantees to see exactly what they cover. For example, a fund may be guaranteed as capital stable over a monthly period, or it may be guaranteed over a yearly period, which means that there could be fluctuations below the capital value during that time.

Remember - guarantees are only as good as the company providing them. Satisfy yourself that the investment is suitable by asking questions and by carefully reading all the information provided. And past performance does not predict future returns.

4. Diversify or spread your investments

Are you varying your investments to reduce the risk?
Diversification aims to reduce the risks by investing money in a range of companies or products and by ensuring it is available at different times; that is, 'not putting all your eggs in one basket'.

You may want to spread your money with several different institutions, with various investment types and across different markets, such as cash, fixed interest, shares and property.

If you are investing in fixed interest investments, it may be wise to spread your money so that you have different maturity dates. This reduces some of the risk if interest rates change. It can also provide you with income on a more regular basis.

While you should always spread your risk over a number of investments, having many small investments may involve you in a lot of supervision, and the returns may be lower.

5. Balance the risks and returns

What level of risk are you willing to take for the returns involved?
A basic rule with investing is 'the higher the return, the higher the risk'. Risk refers to the chance or possibility of loss, or not getting the return you expected. Risk levels can vary with:

* general changes in the economy;
* changes in interest rates;
* the expertise of those managing the company or fund;
* currency exchange rate movements between countries.

Many investors who have been attracted by promises of high returns have lost money by not carefully considering the risk. Investing safely means not investing in a product just because everyone else is. When the interest rate being offered is unusually high, always check the risks involved. If a return looks too good to be true, it probably is.

You should consider not only the risk of losing some or all of your money, but also the risk of not getting the returns you expected. To minimise your risk, your best investment may be a savings account or term deposit.

If you have already retired you may not be able to replace any losses. Therefore you may prefer to settle for a lower, but steadier, return rather than to risk your life savings on an expectation of greater returns.

If you are a younger investor, you should consider growth on your investments. Remember, growth means some level of risk.

6. Manage your debts

How much debt can you afford?
When you are no longer working, debts can be much harder to repay. If you can, pay off all your loans. Exceptions to this rule may include loans with low interest rates such as Defence Service Home Loans. If you are retired and get a social security or veterans' affairs pension, you may find it difficult to get loans from financial institutions. You may consider keeping credit cards and loan facilities open to cover emergencies, although controlling how much you spend on them is important.

Retirement is not a time to take on debt, as you may not have a way to earn extra money to solve any problems.

Home Equity Conversion loans are different from other types of loans in that the loan repayments can be deferred - they can be paid from your estate.

7. take advantage of compounding earnings

How does compound interest work?
Interest earned on most investments can either be paid to you to spend, or it can be reinvested. When you reinvest the interest earned, that interest earns more interest. This is called compound interest.

Comparing the effect of compounding:

Say, for example, that you invest $10,000 in an interest bearing account for 10 years and earn 7 per cent interest per year.

With no compounding: at the end of 10 years you would still have your original $10,000. You would have earned $7,000 in interest, giving you $700 each year to spend.

With compounding: at the end of 10 years your original $10,000 would have grown to $19,672. You would have earned $9,672 in interest, although this would not have allowed any spending money. By compounding your money, this investment would have earned you an extra $2,672 over 10 years.

Compounding interest helps your investments grow at a faster rate. Compounding also applies if you reinvest share dividends or distributions from managed investments.

If you decide to compound the interest, tax is still assessable on the interest earned each year. Depending on your circumstances, you may need to set aside money to pay the tax.

Leaving your money in a superannuation fund until your final retirement, or putting more money in earlier in life, is a very effective way to take advantage of compound returns.

[This message has been edited by Share_market_information (edited 08-02-2003).]

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