In the first of a seven-part series on investing, Bell Direct’s Head of Distribution and Marketing, Tim Sparks, explains what you need to know before making the transition from a saver to an investor. Or, what you need to know before you place your first share market trade.
“I’m getting around to it” is a statement which is said way too often when it comes to setting an investment goal.
Whether you are a young adult who is looking to build financial assets or an older person who is new to the world of investing, there is no doubt that becoming an investor rather than a saver involves a learning curve.
But the good news is, if you have already established the financial discipline to save regularly, you are already part of the way there. Even better, if the goal you are working towards is some years away, you have time on your side for your investment returns to compound. Utilising the stock market within a regular savings plan can produce long-term benefits. Consider these two strategies:
Investing $10,000 and watching the returns over 15 years.
- Invest $10,000
- 15 years
- 8% p.a. (historical return).
End balance: $26,642
The blue line represents the investment returns of the largest 200 stocks on the Australian stock market.
Investing $10,000 with a regular savings plan and watching the returns over 15 years.
- Invest $10,000
- Monthly contributions of $200
- 15 years
- 8% p.a. (historical return).
End balance: $85,264
You can see the orange line, the initial investment and regular savings plan, would now be worth $85,264. So that $200 contribution per month (or $50 per week) created an extra $58,622 in long term value.
That’s the beauty compounding returns and a plan. Albert Einstein said of compounding ‘compounding is the most powerful force in the universe… the greatest invention in human history.’
In recent years investing in a diversified portfolio has gone from being a complex process to a relatively simple one, with the explosion of innovative products such as Exchange Traded Funds (ETFs), which offer access to a diversified portfolio accessed via the Australian Securities Exchange (ASX).
However, when it comes to investing, there is still so much information out there that it can be difficult to know where to start. Therefore, we have developed the Bell Direct Investment Principles to help get you started.
- Focus on an investment goal
- Decide on a timeframe
- Keep costs low
- Diversify to minimise your risk
Bell Direct’s Investment Principles
1. Focus on an investment goal
Investing is just a way of saving – but not in a bank account.
Before you decide on the right investments, it is important to determine what it is you are investing for. Many people have more than one investment goal – for example saving for a new car, saving for a house deposit and saving for retirement. It is important to remember that you may need different investment strategies for different goals.
2. Decide on an investment timeframe
Break down your investment goals into short, medium and long-term goals. This will determine the investment timeframe for each goal.
As a rule of thumb, for medium term goals such as saving for a house deposit over five years, you can typically afford to take on more risk as you have more time to ride out market ups and downs.
If, however, you want to buy a new car in a year or two, you will likely be slowed down by historically low interest rates if you are saving in a bank account and may need to expand your investment horizons beyond bank deposits.
To get your money working a bit harder there are a range of investment options higher up on the risk scale. Many savers are moving from term deposits into diversified share portfolios in an attempt to capture higher returns.
3. Keep costs low
With an array of low-cost investment options now on the market, it pays to shop around for the right investment product for you.
Of course, if you are looking to access professional management, it can be worth paying more but it’s important to understand the fees you are paying and the reasons you are paying them.
For example, you can invest in a managed fund or ETF offered by U.S. companies such as Vanguard or BlackRock and they will invest your money for you. However, these U.S. fund managers will also charge you money (a fee) to do that. Typically, they charge you a percentage of the money you invest. Say you invested in a managed fund costing 0.2%, then a $10,000 investment that returns 8% p.a. over 10 years would cost around $300. The same $10,000 investment at 1.2% would cost about $1,670. So if you selected the low cost investment that’s $1,370 you keep in your pocket from that one decision alone as shown on the table below.
The U.S. fund managers charge you this fee every year regardless of how your investment performs.
Another option is to invest in the stocks directly, which means you could save even more. This is because unlike managed funds and ETFs, if you select your own stocks you do not incur ongoing or annual fees.
Later in this educational series, we will be analysing portfolios investors are constructing using a combination of U.S. fund managers and their own expertise.
4. Diversify to minimize risk
How you choose to invest across different asset classes is known as your strategic asset allocation.
Most investors have a mix of growth assets such as shares in their portfolio, along with more defensive assets like fixed income and cash.
Growth assets are named as such because they are expected to grow in value. For example, just say you bought Woolworths for $30. In 10 years’ time you may expect the share price to be worth more as Woolworth’s management implement their competitive strategy to grow the company.
Defensive assets are named as such because they are expected to provide an income stream. For example, if I put my money in a bank the value of the deposit doesn’t go up and down however, I receive an income stream in the form of interest.
As the price of my Woolworth’s share will go up and down more than my bank deposit, we can say that an investment in Woolworths shares is more volatile than a deposit in the bank.
Different asset classes perform well at different times in the market cycle, so a diversified portfolio investing in a combination of growth assets and defensive assets can help to lower volatility in your portfolio returns over the long term. Basically it’s a smoother ride.
Let’s say Charlotte, a young investor, wants to save for a house deposit and gives herself a five-year timeframe to achieve her goal. The most important point here is that time in the market is her friend because share markets go up over the long term.
The black line in the chart below shows a diversified investment portfolio made up of 30% defensive assets and 70% growth assets. An investment portfolio weighted this way is commonly referred to as a ‘growth’ portfolio.
We can see that over a five-year investment time frame $10,000 invested has grown to about $13,550 (black line). We can also see the Australian share market (red line) grew about the same in that time. The light blue line shows the investment in cash delivered far lower returns over the period.
As seen in the graph, the nature of the market means there are dips and rises over time. Remaining steady in line with your investment goal and blocking out market noise is imperative – while there were a few negative periods over the five years, the diversified portfolio still grew substantially.
The diversified portfolio had around half the level of risk of the Australian share portfolio, meaning it was less volatile and provided a much smoother path to reaching the intended goal (especially in 2015 and during the COVID-19 crisis, check out the black line verses the red line at those times). This shows the benefits of mixing growth investments with defensive investments. The combined investments generally fall by less when global stock markets are falling, providing income and greater peace of mind as you move towards your investment goal.
As a first step, spend a little time working out what your investment goals are and in the next article in the series we will look at the investment options available to help you build a portfolio.
Top three take outs
While taking the investing plunge may seem daunting, the Bell Direct Investing Principles can help you get started
The sooner you get started, the better – it’s all about time in the market because you benefit from the miracle of compounding returns!
At the very least, consider what you are trying to achieve and your timeframe – this will set you in the right direction. If you can select a portfolio of stocks on your own you will not have to pay an annual fee to a U.S. fund manager.
Important Disclaimer- This information is for educational purposes only and is of a general nature. It has been prepared without consideration of your specific financial situation, particular needs and investment objectives. This information does not constitute financial advice and you should consider your own financial circumstances in assessing the appropriateness of this information.