Wealth creation through investing is not just for the rich, it is something that is available to all of us.
Investing is about putting your money to work now, in preparation for your financial security in the future.
The key to any successful investment when there are so many choices, is to gain an understanding of the investment fundamentals.
Set some personalised goals to suit your circumstances and decide on the level of risk you are comfortable to take.
No matter what your financial situation is, it’s never too early or too late to begin thinking about ways to build wealth.
BUDGETING AND DEBT REDUCTION
Budgeting is the foundation of good financial management and is essential when you are considering making any investments.
A budget shows you how much money you have and how your money is spent, allowing you to keep your expenses under control.
When creating your budget, you need to look at all the income coming in and all the expenses going out to be able to assess if you are living within your means. If you have money left over, you can contemplate putting this to work for you via investing.
Another important step to moving ahead financially is to reduce or eliminate any high interest debts like credit cards, as the longer you owe money on this type of credit, the more interest you will pay.
SETTING CLEAR GOALS
Setting well-defined goals with a clear timeframe is a vital step for creating wealth. It will enable you to work out the type of investment that will best help you reach your goals.
Decide what it is you want the money for, when you need it by and calculate the amount you will require to achieve it.
Choosing the right investment for your situation is much easier when you have clear goals in mind.
Generally, the longer you have to achieve your goals, the more measured risks you can afford to take with your investments and the greater rewards you could expect to gain.
OBTAINING FINANCIAL GUIDANCE
Before undertaking any major financial decision, it is advisable to seek professional guidance from an accountant or a financial advisor. A financial professional will perform a risk profile on you to evaluate the level of risk that is optimal for you.
You can share with them your purpose for investing and they can help you set the relevant goals to get there. Ask them all your questions and look into any tax benefits available with your investment choices.
You can then proceed with investing with the confidence of knowing that you are making a well-informed decision.
DIVERSIFICATION
You have probably heard the saying “don’t put all your eggs in one basket” and that saying is
especially true when it comes to investing.
The practice of spreading your money across a number of different types of investments is known as diversification.
It is possible for investments to go down in value, so diversifying your investments is a good way of managing the risk of having all your investments perform badly at the same time.
RISK PROFILE
Different investments pose different risks, and the consequences of these risks can be
relatively minor or perhaps quite considerable. The general rule is that the higher the risk, the higher the potential returns.
The opposite is also usually true. Therefore, it is important for you to work out what level of risk you are comfortable taking.
Your risk profile looks at what level of risk you are willing and able to take on. This may change as your circumstances change. (E.g. The level of risk you find acceptable when you are young and single may be different to when you are married with children or approaching retirement.)
MAJOR ASSET CLASSES
Investments can be split into several broad categories, usually referred to as the major asset classes. Each asset class performs differently, offering different levels of risk and reward.
The right asset class for your investment will depend on your goals, your time in the market and your risk profile. Some of the major asset classes are:
1. Cash.
2. Fixed Income.
3. Property.
4. Shares.
CASH
Cash assets are referring to the money you might put into a savings accounts or term deposits to earn interest.
By leaving the interest payment in your account, you will earn interest on the interest. This is called compound interest. Compound interest gives your savings an extra boost with little effort on your part.
Investing in cash assets offer little to no risk and generally provide a stable rate of return.
Being the most liquid of all the investment options, it offers easy access to your money when you need it.
Although cash assets offer peace of mind because there is little or no risk of losing money, unfortunately this is the lowest performing asset type over the long term.
FIXED INCOME
Fixed income investments generally refer to bonds.
In Australia, bonds are issued by the Australian Government (lowest risk) or a company (higher risk), in order to raise money for various projects and investments of their own.
By purchasing a bond, you are lending money to them for a set period of time. In return for this, they will pay you back with regular interest amounts (known as coupon payments). At the end of the term, you will receive your capital back.
Bonds are most suited as a long-term investment and they have terms of up to 30 years. They provide a stable income stream and a better rate of return than cash investments.
Access to your money is limited during the fixed investment period because you usually have to wait for the bond to mature before your capital is repaid. However, you do have the option of selling your bonds before that time, and you could make a profit or loss depending on the market price at the time.
PROPERTY
Property assets refer to investment in all types of Real Estate.
Property is a popular choice when it comes to investing money as it offers investors the combined benefit of rental income, along with capital growth and possible tax benefits.
Traditionally property has been less volatile than other investment choices. Over the medium to long term, property generally outperforms cash and fixed-income assets.
The property market does fluctuate, however, history has shown most properties to grow in value over time.
Investment in property can be made through direct ownership (buying an investment property) or through property trusts and managed funds.
Direct Property (Buying an Investment Property)
Many Australians feel comfortable investing directly in physical property as they gain a tangible asset.
Investment properties can offer multiple tax incentives and there is also the added benefit of only investing a portion of what the asset is worth yourself, as the rest can be leveraged (borrowed).
There are however some disadvantages that need to be considered also.
Investing in property involves more time and effort than some other investment assets as finding the right property can be difficult and time consuming.
To invest in property directly requires a significant financial commitment upfront, generally a large cash sum for the deposit and stamp duty and the remainder through an investment property loan.
When it comes to selling your investment property, it may take you some time to find a buyer, making it difficult to turn your asset back into cash if you need to access your money quickly.
Property Trusts
Property trusts allow you an opportunity to take part ownership in a property.
Your money is pooled with the money of others in the trust, enabling you to outlay a much smaller initial investment than you would if you were purchasing a property alone, or it can give you the chance to be part of a more extravagant investment you may not be able to afford to be part of alone.
There are many complex rules and regulations in regards to property trusts so be sure to do your research.
SHARES
Shares (also known as stocks and equities) are units of ownership in publicly listed companies from Australia and around the world that are traded on the Australian Stock Exchange (ASX).
When you buy shares, you are effectively buying part ownership of that company which entitles you to a share of the company’s profits, which is also known as a dividend.
The total amount you receive is dependent on the number of shares you own as the dividend is calculated as an amount per share.
Shares need to be purchased or sold directly by signing up with a stockbroker. You may then elect from two different buying and selling options:
a) The stockbrokers can buy and sell shares on your behalf and actively manage your share portfolio. Although this is the more expensive option, stockbrokers know the market and their expertise and advice can be invaluable.
b) Use an online share-trading platform and make the trades yourself. Ensure you educate yourself on how to invest wisely before undertaking this role.
Over the long term, shares normally outperform all other asset classes, offering a combination of high income and high growth. However, shares are known to be volatile in the short term making it tempting to dump shares performing poorly.
Diversification is key when investing in shares. If you have investments in a number of different companies across different sectors, your investment is less likely to be damaged by losses in one company or sector.
Companies listed on the stock exchange can be grouped into eleven sectors:
Energy, Materials, Industrials, Consumer Discretionary, Healthcare, Financials, Consumer Staples, IT, Utilities, Real Estate and Telecommunication Services.
COMMODITIES
Commodities are everyday goods that are widely available. Things like oil, silver, gold, metals, wheat, corn and more.
The simplest way you can invest in a commodity is by buying it now, to sell at a later date for a profit, perhaps a collectable item.
Investors also take part in commodity future trading. This is where they bet on which way a commodity’s price will go. They may also trade commodities in the share market.
If you want to try a bit of everything when investing in commodities you can put your funds into Exchange-traded funds (ETF’s).
Commodities are quickly being added to the list of major asset groups and depending on your goals might be a worthwhile addition to your investment portfolio.
EXCHANGE TRADED FUNDS
An Exchange traded funds (ETF) is essentially a combination of a managed fund and shares.
While a share invests in one company, an ETF can invest in many at once.
You purchase and trade ETF’s with the same ease and affordability that you do with shares, however, the difference is an ETF has a diverse portfolio similar to a managed fund.
An ETF provider puts a puzzle together by choosing a mix of assets (e.g. bonds, commodities, real estate and shares) and then you buy a piece of this puzzle.
Exchange traded Funds have become a very popular option as is a simple way to gain exposure to various assets.
Unlike a mutual fund you can see exactly what your ETF is being invested in.
MANAGED FUNDS
A managed fund works by pooling your investment with money from other investors to buy assets.
Managed funds can purchase assets in all major asset classes, but some funds might choose to buy assets in one particular asset class only.
An effective diversification strategy is to invest in a mixture of assets across all classes. This is usually referred to as a ‘balanced fund.’
Managed funds are also known as managed investment schemes, unit trusts or managed trusts.
As an investor, you receive a certain number of units in the managed fund and a professional investment manager will handle the portfolio for you. You have the option to choose the types of assets you want to invest in, but you cannot control the exact assets that your funds invest in.
Typically, managed funds are a long-term investment because of their exposure to the stock market. They can offer good potential for capital growth and a good income stream over the long term.
DERIVATIVES
A derivative is another type of financial product and is named as such because the value of a derivative is ‘derived’ from the price of the underlying financial product. The underlying financial product can be a stock, currency or fixed interest product.
Derivatives are contracts to buy or sell the underlying asset at a future time, but the price, quantity and other specifications are defined today. That means they are contracts that call for money to change hands at a future date with the amount of the transaction determined by the share price, exchange rate or other reference item.
The most commonly known types of derivatives are warrants, futures and options.
Derivatives are a sophisticated investment strategy. If you are interested in learning more about derivatives, speak to your financial adviser.
CRYPTOCURRENCY
Cryptocurrency is still in its early stages but has become a popular investment opportunity using its digital/virtual currency system.
The most well-known cryptocurrency is Bitcoin, but there are many other alternatives to this.
You can purchase cryptocurrency through an online ‘crypto exchange’. In order to buy it, you need a wallet app on your phone which will hold your currency. You then transfer money securely, which will purchase you these digital/virtual tokens.
To use cryptocurrency as an investment, a buy and hold strategy is best and when the market rises, you can sell it at a profit.
Investing in crypto assets is highly volatile but in the long term has the potential to reap high rewards.
MARGIN LENDING
Margin lending means borrowing to invest, typically secured against your cash or investments.
Investing a combination of your own savings and your borrowings gives you more to invest and therefore the potential for increased returns.
Provided that you can contribute about 20% of an investment through your own savings, you may be able to borrow the remainder to buy shares or managed funds using margin lending.
The main benefit of margin lending is you can increase your potential gains because you have invested more. Of course, the opposite can also be true.
The interest incurred on margin loans is generally tax-deductible, so gearing can be an effective way of minimising tax.
TAX FOR INVESTORS
There are a number of legitimate tax-minimisation strategies available to investors which
enable you to make the most of your investments.
On the other hand, there are also some unique taxes applicable to investments that you should be aware of, so that you can factor these into your investment calculations and decisions.
Capital Gains Tax
Capital Gains Tax is paid when your capital gains are higher than your capital losses in any one financial year. A capital gain is made when you sell an asset for more than what you paid for it. A capital loss is made when you sell an asset for less than what you paid for it.
This tax applies to all investments, including property, shares and managed funds. However, it does not apply to your home where it is your primary residence.
Negative Gearing
Negative gearing occurs when an investor borrows money for an income producing asset (such as a property or shares) and the interest payments on the loan are higher than the income you receive from the asset.
The losses can be claimed against your other taxable income, such as wages.
The strategy of negative gearing is usually beneficial where the capital growth of the assets outweighs the effect of the shortfall.
Franking Credits
All Australian companies must pay tax on their earnings. After tax has been paid, the company’s profits are distributed to shareholders by way of dividends. Shareholders are also required to pay tax on the income they receive from the dividends.
So that tax is not paid twice, by the company and the shareholder, the shareholder receives a franking credit. The franking credit (also known as an imputation credit), represents the tax already paid by the company. It is used as a rebate for the tax already paid by the company and reduces the amount of tax you pay on your income.
SUPERANNUATION
Every Australian worker has an investment in superannuation. That’s because the Federal Government has made it compulsory for your employer to pay a percentage of your pre-tax income into superannuation as contributions on your behalf.
Superannuation is a long-term, tax-effective investment, which is intended to remain untouched to provide money when you reach a certain age and retire.
Super money can be accessed as an income stream or in a lump sum.
In addition to what your employer contributes, you can also add money to superannuation to support your financial future.
When you start out in the workforce, you have the option to join your employer’s superannuation fund of choice or you can choose a fund of your preference.
Superannuation funds can differ quite greatly, so look into the fund’s performance, its investment strategies and returns, any fees charged and any additional death and disability benefits included.
Ensure you transfer any money from your old super account to your new super account when you open it. Not only will you save money in fees but in pooling your money, you may get a better return.
Choice Of Superannuation Fund
There are four basic types of superannuation funds:
Retail Super Funds – Available to any member of the public. Often run by Investment companies.
Industry Super Funds – Bigger funds are available to anyone, but smaller funds may only be for those working in a particular industry.
Corporate Funds – Arranged for people working for a particular company by their employer.
Public Sector Super Funds – This is for Government employees.
Self-Managed Funds – These do-it-yourself (DIY) super funds are generally only worthwhile for high-income earners or investors with substantial assets
Superannuation Contribution Options
There are a number of ways your superannuation account can grow:
Employer Contributions – these are payments made into your superannuation account by your employer, on top of your regular wage or salary. Each year, your employer must make contributions equal to at least 10% of your gross pay and some employers may contribute more. While your employer is only required to pay contributions to your superannuation account on a quarterly basis, they may be willing to make payments monthly, which will earn you more.
Salary Sacrifice – another way of adding to your superannuation is by taking less salary upfront and having your employer contribute the ‘sacrificed’ amount to your super. Not only are you putting more money away for the future, it can also be a very tax-effective option.
Personal Contributions – you also have the choice of adding to your superannuation account by making personal contributions from your after-tax income. Depending on your income, the government may also match your contribution.
Superannuation Investment Categories
Funds are usually categorised according to the expected level of return and the underlying risks
associated with the investment. Like managed funds, you may not be able to control the exact allocation of assets your superannuation fund invests in, but you may be able to select the types of assets you want to invest in. The four main categories are:
Growth – Funds that invest mostly in shares or property. They generally have the highest returns over the long term, but are exposed to large losses in bad years. A growth fund is most suited to investors with at least 7-10 years left before retirement. Over this time period, the gains will normally be greater than the losses.
Balanced – Funds that invest a large amount in shares and property, as well as some investment in less risky asset classes, such as cash and fixed-interest. Many balanced funds also offer strong return, but less than growth funds.
Conservative – Funds that invest in a low amount of shares and property and a high amount in less risky asset classes, such as cash and fixed-interest. Very low risk but consequently lower return is expected. This is a suitable investment style for your superannuation if you are in the market for less than 3 years.
Cash – Funds that invest 100% in deposits with authorised deposit-taking institutions in Australia, such as credit unions, building societies and banks, or in investments in a capital-guaranteed life insurance policy. These funds have minimal risk, very low returns and are suited to investors who want to park their superannuation somewhere for 1 – 2 years maximum.
How Much Superannuation Will I Need To Retire?
The amount of superannuation you will need on retirement varies from person to person.
It will generally depend on the level of income you want each year for your retirement and the number of years you will need your superannuation to last.
As a general rule, it is recommended that your retirement income should be approximately 65% - 75% of your pre-retirement income (after tax) to maintain your existing lifestyle. You need to ensure that you have sufficient superannuation savings to provide this amount for the remainder of your life.
Employer contributions alone may not be enough to cover this, so you may need to consider topping up your superannuation through salary sacrificing and personal contributions.
Accessing Your Superannuation
Generally, you cannot access your superannuation savings until you retire from the workforce and reach your ‘preservation age’. If you are born after 1 January 1957, your preservation age is sixty-seven, but for people born before that date, the preservation age is younger.
In some cases of severe financial hardship or permanent disability, you may be allowed to access your superannuation before you reach your preservation age.
It is possible for you to work part-time after you have reached the preservation age and draw down some of the savings from your superannuation fund. This allows you to supplement your part-time wage with your superannuation savings so that you don’t have to leave the workforce altogether.
When you retire, your superannuation will be paid to you in either a lump sum, a pension or as a combination of both, depending on what you choose.
MAKING A WILL
Investors can build a sizeable investment portfolio over their lifetime and it is important to ensure that, on your death, your assets are distributed as you wish. Having a Will is the only way that you can make certain that your assets will go to your beneficiaries according to your instructions.
The most common way of making a Will is to seek legal advice from a solicitor, who will prepare a valid Will for you. Contrary to what you may think, having your solicitor prepare your Will is not too expensive and may be well worth it in the long run.
Your solicitor can assist by talking through different options and different outcomes so that your Will truly reflects your wishes. A professionally prepared Will may also relieve your loved ones of stress and anxiety after your death.
As an alternative, you can obtain a Legal Will Kit from a newsagency or post office, which outlines the wording required to make a valid Will. This is a cheap and easy alternative and may suffice if you have a very straightforward Will.
Wills are equally important for younger people as they are for older people. A young person may die in tragic circumstances and they may not have time to get their affairs in order before they die.
It is important to keep your Will up to date. It may seem morbid, but it will save your family heartache and stress if the unlikely does happen.
Times To Change Your Will
As time passes and your assets and personal circumstances change, it is important to review and update your Will. While this does not have to be done too regularly, there are some key life events that should prompt you to consider reviewing your Will, such as:
a) If you get married or divorced, or enter a new relationship.
b) If there are new members to your family or new dependents.
c) If a beneficiary on your existing Will passes away.
Your Will may be changed in two ways:
a) You can prepare a new Will, which automatically revokes any previous Wills.
b) You can make a codicil to your existing Will, which is a legal addition.
What Happens If You Die Without A Will?
‘Intestate’ is the term given when someone dies without a legally binding Will.
In this case, what happens to your assets and how they are distributed is determined by legislation.
Your assets are usually distributed according to a standard formula, but this can take much longer and be more expensive than if you had a valid Will at your death. It can also mean your assets are distributed in a way that is inconsistent with your preferences.
In general, your surviving spouse or partner and then your children are taken care of first. If there are no children, your partner inherits the entire estate. If there is no partner, your children inherit everything equally.
If you do not have a spouse, partner or any children then a search is made for next of kin, and usually your parents, if they survive you, receive before your siblings. If no next of kin can be found, and no other eligible person makes a claim, then your entire estate may go to the state.
If you have a sentimental or valuable item that you wish to bequeath someone, then naming it specifically is critical. However, if your intention is to give a person an asset for their benefit, such as a car, then naming it by make and model can create a problem if you change cars before you die, so simply refer to the asset simply as a car.
Choosing An Executor
The Executor is the person you nominate to carry out your instructions according to your Will. The role of the Executor is to deal with third parties, such as the government and insurance companies, to ensure that your affairs are handled as you wish. The Executor will gather your assets and pay off any remaining debts before distributing your assets to your beneficiaries and preparing your final tax return.
In choosing an Executor (or joint Executors) for your estate, you should consider choosing someone likely to survive you and who will have sufficient time, care and skills required to take care of your affairs. It is also important to tell the person you would like them to be your Executor and to tell them where your Will is stored.
POWERS OF ATTORNEY
A power of attorney is a legal document enabling another person to act for you, including being able to sign legally binding documents on your behalf.
Depending on the power of attorney you make, your attorney can make financial, health and/or lifestyle decisions for you. Power of attorney may cover a broad or restricted range of matters. You decide the scope of the power. Is it for financial reasons, a specific purpose or for medical reasons following an operation? You also decide the timeframe for the operation of the power.
Different laws apply to different powers and different States and Territories may do things differently, so make sure you find out the necessary rules to ensure you grant your attorney the power you wish for them to have.
Types Of Power Of Attorney
There are two main types of power of attorney - General and Enduring.
General – this power operates only when you are legally capable to make decisions for yourself.
This type of power is used mostly for more immediate purposes, like settling a property you are purchasing while you are overseas, where specific decisions need to be made and you are not available to make them.
General powers of attorney can be limited by including conditions that specify exactly which decisions can be made. This power expires on your death or loss of mental capacity.
Enduring – this power operates from the time specified for its operation and remains valid even when you can no longer make decisions for yourself.
The main advantage of an enduring power of attorney is that, while you have capacity, it allows you to plan for the future and you can specify whether the power covers financial, medical or lifestyle decisions or all of these areas.
A financial power of attorney is used for making financial and legal decisions, including:
• Doing your banking.
• Signing legal documents.
• Transferring assets and investing income.
• Collecting or paying rent.
Medical and lifestyle powers of attorney are used for making health and lifestyle decisions,
including:
• Consenting to medical treatment.
• Deciding where you will live and with whom.
• Approving a care or management plan.
How Do I Make A Power Of Attorney
Making a power of attorney is a relatively straightforward process, but there are some rules that need to be followed, such as witnesses to sign the document.
The safest way of making a power of attorney is to have it prepared by your solicitor. They will ensure you fully understand the implications and that the document is prepared correctly and is generally an inexpensive exercise.
Another option is to prepare your own power of attorney document. You can buy a power of attorney form or kit from a newsagent.
Forms may also be available on the Internet, but if you plan to do it yourself, ensure you understand the form and how it must be completed, signed and witnessed, otherwise it may not be valid.
Choosing An Attorney
The person you choose as your attorney must be legally competent. This means they must understand the nature and effect of the power of attorney, including what they can do, when they can make decisions and the effects of their decisions.
It’s vital that you trust the person you appoint as your attorney and that the person has a clear understanding of the decisions you would be likely to make in certain circumstances.
It is also a good idea to check that the person you choose is happy to act as your attorney and is likely to be available when needed.
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