Goal setting means thinking about what is important in the medium to long term, how much those goals will cost and how you plan to afford them.
The amount of capital you have available for immediate investment will include the value of your current investments, any surplus after-tax income and, potentially, the value of some of your general assets if you are prepared to sell or borrow against them.
Investment risk refers to both the possibility of loss and uncertainty about future conditions.
Your attitude towards risk will affect how much money you make available for investment and how you invest it. To determine your risk profile, you should consider the following questions:
• How comfortable are you with risk and not being able to control some aspects of investment?
• Are you prepared to expose some of your money to higher risk for the opportunity of making higher returns, or are you more comfortable with low-risk, low-return investments?
• How reliable is your income and are your budgeted expenses realistic?
• Do you have a large amount of debt?
Timing is another factor in determining your investment objectives. If you need funds to achieve short-term goals, you should invest in areas that are more likely to perform earlier rather than later. Alternatively, you may wish to grow your investments over the long term.
Requirements regarding timing, as well as your current lifestyle needs, will determine the returns you should seek from your investments.
When considering how timing may affect your investment objectives, ask yourself whether you require:
• a return in the form of income to support your current lifestyle
• a return in the form of capital growth to increase your wealth over time
• a combination of income and capital growth.
A popular saying is ‘don’t put all your eggs in one basket’. It can apply to many things, but it applies particularly well to investing in the sharemarket and the need for diversification.
Markets move in cycles. Some investors fall into the trap of putting all their money into one asset class – usually when it is at its peak – and then watch as another asset class takes off without them (an asset class is an investment area such as shares or property). The sharemarket is one asset class you can use to diversify your portfolio.
There is much debate as to how many stocks you should invest in to achieve prudent diversification, and this is something you need to consider and discuss with your adviser if you have one. Some advisers recommend having more than 20 stocks; others suggest that with a wary eye to correlation you can create a reasonably diversified and balanced portfolio with 10 or 12 stocks.
Once you have assessed your current financial situation and developed your future plans, you should be ready to start looking at different investment strategies and working out which strategies best suit your needs and objectives.
So if you’re ready, let’s get started!
CHAPTER 2
What is a share and what is the sharemarket?
A share is simply part-ownership of a business. A company can raise money to finance its business by ‘going public’. Going public means being listed on a stock exchange and issuing shares to investors. When you buy shares in a company, you own part of that company.
The money that a company raises in the sharemarket is called ‘equity capital’. Unlike debt capital, which is borrowed money, equity capital does not need to be repaid as it represents continuous ownership of the company.
As a shareholder you have certain rights and obligations, and you also share in the risks associated with the fortunes of that company.
Shares in a listed company can be sold to other investors on the sharemarket. In this way, you can realise capital gains if the share price has risen – in other words, you can make a profit by selling the shares for more than you paid for them. As a shareholder you may benefit by receiving income in the form of cash distributions, called ‘dividends’.
As a part-owner in the business you may be entitled to vote on the direction of the company, the election of new company directors or other matters.
All shareholders should be aware that the value of a share can fall to zero. In the case of a company going broke and being wound up, shareholders rank close to last in the list of people who can claim money from the sale of the company’s assets.
There are a number of approved securities exchanges in Australia, the largest of which is the Australian Securities Exchange (ASX), which has more than 2000 companies on its Official List.
The sharemarket may be thought of in terms of its two separate market functions: the primary market and the secondary market.
If a company wants to set up a new business or expand its existing business it can raise the money (capital) it needs by issuing new shares to investors. The investors who invest money by buying these shares become shareholders in the company.
Companies that want to issue shares on the sharemarket must first be listed on an approved securities exchange. Most get listed on the ASX. The requirements for listing include being large enough to achieve a market in its shares and agreeing to abide by the ASX Listing Rules. These rules require listed companies to inform the sharemarket of any activities that may affect the price of the shares on the market and to report company profits and other specified financial information.
Many people invest in the sharemarket by participating in the initial public offering (IPO) of shares made by a company listing on the ASX. Access to public floats can vary considerably depending on the size of the float, how many shares are being made available, whether a large portion is allocated to institutional clients or retail investors, and of course whether there is a demand for shares in the company.
The terms ‘IPO’, ‘float’, ‘listing’ and ‘going public’ are often used interchangeably.
After a company has completed its float and issued shares to investors, the shares can be sold to other investors on the sharemarket. This is referred to as the secondary market.
Share trading takes place through the agency of stockbrokers who enter buy and sell orders on behalf of investors.
The price of the shares is determined by the forces of supply and demand, with investors deciding what they will pay for shares in individual companies or what they will accept for shares they already own. The growth and profitability of the companies, alongside other external factors, influence these decisions.
Now that you have an understanding of the market itself and the difference between the primary and secondary market, it is time to talk about your choices when it comes to investing.
CHAPTER 3
The main investment areas: cash, fixed interest, property, shares
This chapter contains general factual information on the main investment areas and does not constitute financial advice. You should seek independent advice from an Australian Financial Services (AFS) licensee prior to making any investment decisions.
Financial advisers are often asked, ‘Where is the best place to invest my money?’ In asking such a question, their clients might be hoping to be told that there is one sure bet – for example, that shares are better than interest-paying investments or that property is the best method of increasing wealth. Of course, depending on your financial goals and objectives, one particular form of investment may