Step by step guide to building wealth
What you'll learn in this step: Diversifying your investments reduces
your risk.
Making the move from saver to investor is your first step on the road to building
wealth. It's only by putting your money to work that you can really get ahead.
There are five basic categories of investments: Australian shares, international
shares, property, fixed interest, and cash. These are often referred to as asset
classes. Within each asset class you can diversify further. For example, within
Australian shares you can choose industrial blue chip or resource stocks. The
idea is that the more widely you spread your investments across and within these
classes, the more you reduce your risk.
 It
is possible to over-diversify if you have lots of small amounts invested in
too many shares. Any price increase would have a negligible effect on your total
portfolio. Under-diversification occurs when you have too much money invested
in too few shares or only in a particular industry.
Learn more: The $5000 fortune starter,
Personal Investor, February 2003
A few thousand dollars may not seem much to begin a fortune, but starting small is a great way to learn the principles of investing without risking too much.
Rebalancing your portfolio
Rebalancing your portfolio occurs when you decide to change the amounts you
have invested in each asset class. For example, you may have started your investment
portfolio with 30 per cent invested in shares, 30 per cent in property, 30 per
cent in fixed interest and 10 per cent in cash. One year down the track with
a booming sharemarket, you may now have 40 per cent invested in shares, 25 per
cent in property, 20 per cent in fixed interest and 15 per cent in cash. This
heavy weighting towards shares may not sit comfortably with your overall strategy.
You may wish to rebalance your portfolio by selling some of your shares and
diverting those funds into property and fixed interest. This usually means you
are selling shares when they are at a high price which is not necessarily a
bad thing as you're taking a profit, and buying into property at a lower price.
Learn more: Safe, safer, safest, The Sydney Morning Herald, 26 Feb 2003
For those seeking defensive investments and reliable income, there are dangers. John Collett and Christine Long report.
Case study
An investment adviser looks at the personal wants and needs of three investors.
Read the full case study, Business
Review Weekly, 12 Dec 2000. |
Asset allocation
Which assets you invest in and how much you invest in each, is determined by
your personality, age, goals and your stage of life. It's what the experts call
your risk tolerance.
Everybody is different. If you want to know your money is safe at all times,
you are probably too nervous to invest too much in the sharemarket. However,
if you like to take a few risks, then only investing in fixed interest investments
would be too boring.
The weighting you give to each investment will depend on your circumstances
and risk tolerance. What it comes down to is working out the right mixture of
shares, property, fixed interest, and cash for your personal risk profile. Depending
on your stage of life, you should end up with a combination of growth and income
assets.
Learn more: Playing it safe, The Age,
18 Feb 2002
How turning your back on investment fads can generate big returns. John Collett
reports.
What you'll learn in this step: Understand your personal risk profile
by working through our investment checklist.
When you meet with a financial planner or go online to one of the many financial
supermarket sites, you will usually have to complete a questionnaire that helps
determine your risk profile. Once you know what type of investor you are, you
are able to make more informed decisions about your investment choices.
However, your risk profile is only part of the equation. You also need to understand
what it is you want to achieve. This could be the level of income you want for
retirement or how much you need for school fees. Once you know this, you can
work backwards to find out what you need to do to achieve those goals. Usually
there have to be some trade-offs. If the amount you require is high relative
to the amount of time you have before you want it, then you may have to increase
your exposure to risk or revisit your financial goals.
Learn more: All in the mind, The Age,
28 Jan 2002
Your behaviour when investing is driven by personality traits. Dorothy Cook
reports.
Learn more: I think, therefore I err, The Age, 30 Sept 2002
Financial analysts are turning to philosophy in an effort to understand investor behaviour and risk. Barbara Drury reports.
Investment checklist
In determining your mix of investments, ask yourself some key questions:
- What are your goals?
- What is your investment horizon?
- Do you want income or growth?
- How would you cope if the value of your investments fell?
- What are the tax considerations?
Take the quiz: What
kind of investor are you? Take this quick tongue-in-cheek quiz to find
out
What are your goals?
Are you looking to invest for the short term, maybe to fund your children's
education or buy a car? Or are you hoping to build wealth for your retirement
in 20 years' time? Maybe you want an investment that gives you a regular income
now. Your goals will determine your investment horizon. The longer your time
horizon, the more risks you can afford to take. A slump on the sharemarket tomorrow
may not have much impact on the value of your investment in 10 years, but if
you're looking to cash in your investments in a couple of months, there may
not be enough time to recover your loss.
Learn more: Investing well? Look to the ancients,
The Age, 01 Apr 2002
Forget modern theory. Here's some practical wisdom to make your money work,
writes Reuven Blecher.
Case study
David is well advanced in his quest to becoming financially independent
and living a healthy, relaxed lifestyle. At the age of 25, he already commands
a good income and owns two properties.
Read the full case study, The Age,
11 Mar 2002. |
Income versus growth
The type of investments you choose will depend on whether you want capital
growth for the future, an income now or a combination of the two. If you want
to receive income on a regular basis, then there's no point in investing in
speculative shares that don't pay dividends. Property trusts, fixed interest
or high-yielding shares are a better alternative.
Alternately, if you want to build up your assets and don't require an income
from them, high-yield investments are not for you, especially as in many cases,
you would lose half of that income in tax.
Learn more: Debt securities,
The Age, 3 February 2003
Just like shares, you can buy and sell debt securities on the market.
What if your investments lost their value?
Say you invested $10,000 in the sharemarket and following a slump it was now
worth $4000. What would be your reaction? If such a scenario makes you nervous,
you are probably better off investing in more conservative investments that
won't keep you awake at night.
But don't think that putting your money in the bank is the only solution.
Any interest you earn would soon be eroded by inflation. Fixed interest securities
or bond trusts are more conservative than shares but provide growth.
Learn more: Fools and their shares,
The Sydney Morning Herald, 11 Dec 2002
Barbara Drury lists 10 of the dumbest things you can do with your shares.
What you'll learn in this step: How to choose a financial adviser.
We are all leading increasingly busy lives and with the growing range of investments
on the market, sometimes it is just too hard to try and determine which ones
are best for you. This is where the guidance of a financial adviser should be
sought. He or she can determine your investment needs and create a plan that
can help you attain your goals. But take care when choosing one. The industry
watch dog, the Australian Securities and Investments Commission, in conjunction
with the Financial Planning Association, has published a booklet called Don't
Kiss Your Money Goodbye, which provides tips on selecting an adviser.
You need to research your financial adviser almost as thoroughly as you would
research your investments. Certainly, don't just settle for the first name you
are given, even if it comes highly recommended by a friend – your needs
could be different to theirs. Arrange a consultation with two or three, and
compare how they operate. It's important that you find out how they make their
money. Do they charge a fee for consultations or do they receive a commission
from the products they recommend? The former style is more likely to lead to
you being given advice that is independent. Many advisers charge to draw you
up a plan and then charge a percentage – maybe between 1-2 per cent –
based on the assets under management.
Holistic wealth support, The Sydney Morning
Herald, 20 Mar 2002
What's the difference between an adviser and an accountant? It's all about
achieving life goals, writes Christine Long.
The key to a good financial adviser is the rapport you build and this is a two-way
process. They need to know all about you in order to give you the most suitable
advice and you need to feel comfortable that they are working in your best interests.
Questions to ask
- Are you licensed?
- What is your previous experience?
- What are your qualifications?
- How do you earn your money?
- Are you linked to a particular finance house?
- What do I do if I have a complaint?
Questions to answer
A financial planner needs to know about you and your goals before they can structure
a portfolio for you. You need to go prepared to discuss all aspects of your
situation – both personal and financial including marital status, children,
your investments including superannuation, and your goals. If the planner tries
to sell you a product at your first meeting, think twice, as they're probably
more of a salesman than an adviser.
Get the right advice
Moneymanager's financial advice special shows you what to look for in a financial adviser, and helps you to understand the their lingo once you have.
DIY wealth, The Age, 29 Jan 2001
If you've got the time, an investment course could kickstart your investment
plans.
What you'll learn in this step: An understanding of tax and how to minimise
what you have to pay.
When it comes to structuring your affairs, there are a number of steps you
can take to minimise your tax liabilities. These include income splitting, timing
of buying and selling your investments, negative gearing, using capital losses
to offset gains and taking advantage of the superannuation environment. One
thing to consider if you are paying the top marginal tax rate, is to aim for
investments that offer high capital growth rather than an ongoing income as
nearly half of any additional income is lost to tax.
Income splitting
If you have a non-working partner or they are on a lower income than you, it
can be a useful strategy to divert some of your investment income into their
name. That way you reduce your family's tax liability. While you can divert
income into a child's name this is not a good strategy as after their income
exceeds $416 they are liable to pay tax at the rate of 66 per cent until it
reaches $1,446 where they pay 47 per cent on the entire income.
Capital gains tax
Most capital gains or capital losses are made from the disposal of an asset that is subject to capital gains tax, such as land and buildings, shares in a company or units in a unit trust. Other lesser-known assets include contractual rights, options, foreign currency, leases, licences and goodwill.
A capital gain or capital loss is the difference between the sale proceeds you receive for an asset and its purchase price.
Changes to capital gains tax now mean you if you buy an investment from 1 October
1999, you only pay tax on half your capital gains if you hold it for more than
12 months.
Investments bought between 19 September 1985 and 30 September 1999 and disposed
of after a year, can have their capital gains tax calculated under the new regime
or using the full inflation indexed gains but with inflation indexation frozen
as at 30 September 1999.
If investments are sold for a capital gain before a year has elapsed, the tax
will be assessed on their total gain without any allowance for inflation and
will be taxed at your full marginal tax rate.
Learn more: A balancing act,
Personal Investor, February 2003
Claiming deductions for rental property is fine, but you have to also know your capital gains tax limitations.
Offsetting capital losses
Of course not all your investments will reap you a profit. If you have lost
money on an investment, consider selling it before June 30 and offsetting the
loss against any gains made from the sale of another investment made during
that financial year. Capital losses can only be offset against capital gains,
not against any other income.
With
investments, you either pay tax on the income or the gain received, or the tax
has already been paid by the organisation you've invested in. Depending on the
amount of tax paid on your behalf, you could have very little or no tax to pay.
Gearing and negative gearing
Gearing is when you borrow money to invest. It might be for a property or for
shares. Gearing allows you to increase your investment and potentially get a
higher return, on the downside however if the investment doesn't pay off you
stand to lose more.
Learn more:Having a lend,
The Sydney Morning Herald, 4 Dec 2002
The strategy: to gear into shares without having to borrow.
Learn more:Getting into gear,
The Sydney Morning Herald, 19 Feb 2003
Investors will need to check that their property strategy is still working if the market stalls, reports Barbara Drury.
Negative gearing is when the interest you pay on your borrowing is greater
than the income from your investment, you can claim this difference against
your tax. But that doesn't mean all negative gearing is a good investment strategy.
You may get a tax break, but it is still costing you money. People negatively
gear because they think they will eventually sell the investment for more than
they bought it for but the risks are that the value of the asset will fall;
the interest on your loan will rise; or you are unable to keep making the interest
payments.
Think
twice about borrowing against your home, particularly for a speculative investment
as you could find yourself without a roof over your head.
Margin lending
Margin lending means borrowing to invest. Investing a combination of savings and borrowed funds allows you to invest more, increasing the potential returns compared to investing savings only. In the same way as property investors will put down a 20-30 per cent deposit and borrow the rest, margin lending allows you to buy a significant share or managed fund portfolio with as little as a 20 per cent deposit. This approach is also known as ‘gearing’.
The negative side is when share prices fall below a certain level and a margin call is made, borrowers generally have 24 hours to respond in one of three ways to restore their loan-to-valuation level: come up with more cash, sell underlying assets or provide additional assets to top up their equity.
If borrowers fail to act in time, the lender will sell some of the underlying assets and the borrower has no say in which assets are sold.
Crunching gears
If you have a margin loan, make sure you are aware of - and understand - all the terms of your loan, then bone up on these survival tips:
Regularly review your ability to make interest payments in addition to any margin calls that may arise.
Monitor your underlying investment portfolio.
Do not borrow to your limit.
Keep your gearing level at 50 per cent or less.
Diversify your portfolio across sectors of the market, fund managers and management styles such as value, growth and index.
Pay your loan interest regularly.
Reinvest all dividends/distributions to reduce the size of the loan.
If you are thinking of taking out a margin loan ask your financial adviser to explain:
The circumstances under which a margin call may be made.
How you might respond to a margin call.
The risk of negative equity where the amount you borrow exceeds the value of the underlying equity.
The tax implications of margin lending.
The relative advantages of fixed and floating interest rates, including any "break" fees if your fixed-rate loan is terminated early.
Sources: ASIC/BT Margin Lending
Learn more:Heart of the matter is to let your head rule,
The Sun Herald, 17 Nov 2002
Using borrowed money to add to your investment is atime-honoured way of fast-tracking your opportunities to make money.
Learn more: Margin lending facsheets
Learn more: Compare margin lenders rates and features.
Superannuation
Superannuation is still one of the most tax effective way of accumulating wealth.
Investment earnings in super funds are taxed at the concessional rate
of 15% which is far less than the marginal tax rate payable on other investments.
However, it is not sensible to invest all your money within the superannuation
environment. Because super is so heavily regulated, you might find the rules
change over time. Also once you've invested in super, your money is tied up
until you are well into your 50s. If you are only in your 20s, you will probably
need to access a lump sum at some stage. It's best to keep some of your money
in more liquid assets that are more easily realised.
Learn more: Why a little sacrifice now can
pay off later, The Age, 11 Mar 2002
Sacrificing your salary can be a way to grow your wealth. Anne Lampe reports.
Investment advice deductions
Money spent on obtaining investment advice can generally be claimed against
your tax. Portfolio management costs, ongoing financial advice (although not
your initial consultation), investment computer software and in some cases subscription
to newsletters can all be claimed.
What you'll learn in this step: The questions to ask to avoid being
taken for a ride.
Successful investments, or ones that are most likely to make you money come
down to quality.
Learn more: Serve and protect, The Sydney
Morning Herald, 23 Oct 2002
There are ways of protecting your investments from the tax man and creditors, writes Noel Whittaker.
Be
wary of properties carrying rental guarantees that are sold on a lease-back
basis. It may be a sign of a weak leasing market.
High returns equals high risk
The Australian Securities and Investment Commission (ASIC) warns that any scheme
offering more than 2 per cent above what the banks are willing to pay on a term
deposit should be treated with extreme caution. See the ASIC
consumer site, Fido for the latest consumer alerts.
Learn more: Dollars & sense,
The Sydney Morning Herald, 22 Jan 2003
Why you can't trust your instincts if you want to be a successful investor.
Learn more: Have house, will borrow,
Personal Investor, February 2003
Home equity loans a great way (for some) to boost investment returns
Do your research
It's your money you are investing, so make sure the advice you receive is sound.
Is the person offering the scheme licensed and authorised to give advice? If
there is a prospectus, read it. Don't get carried awaywith the spiel of a slick
salesperson. Ask questions such as:
- When will you receive your money?
- Can you get your money back at any time?
- What are earnings forecasts based on?
- What commission does the salesperson earn?
- What management fees will you be paying
Learn more: Good advice,
The Sydney Morning Herald, 12 Feb 2003
The strategy: to work out whether my financial plan is good, bad or indifferent.
|
Step 1:
Step 2:
Each week financial advisor Noel Whittaker answers your
questions.
