The Basics of Investment

© Property Professor articles — www.thepropertyprofessor.net.au.
Reproduced with permission.

I generally write articles on property but this week I thought I’d outline some of the basic concepts of investing in the four major asset classes; cash, fixed interest, shares and property.

To invest your money means that you are willing to give up the opportunity to spend the money now as you are anticipating earning more money in the future. In other words, you are willing to make a sacrifice now for an expected future benefit.

Cash
The most common way for people to invest in this asset class is to put money away in a bank account. Compared to the other asset classes, you will receive a relatively low return (currently up to 3.5% pa) but it is associated with a very low risk i.e. you are virtually guaranteed that not only will you get your money back but you will also earn 3.5% interest on the money you invested. Your cash deposit won’t grow in value, you’ll just receive the income based on how much you invested, how long you invested for and the interest rate. You have very good access to your money as you can walk into a bank/make a phone call/access your account on the internet and you can have your money in a matter of minutes.

Fixed Interest
People are able to invest in this asset class by purchasing government or corporate bonds. You will receive a low return (currently around 4.0% pa) but it is associated with a low risk i.e. your money is virtually guaranteed by the government or corporation. You should get all your money back plus receive interest earned at periodic intervals. Your initial investment will not grow in value but you will receive income form the interest earned. You have reasonably good access to your money as you should be able sell your bond on the market within a day.

Shares
People are attracted to the share market because of the relatively high returns. Compared to the other asset classes, shares have the highest capital growth (approximately 9% pa) but they are accompanied by the highest risk. Share investors are anticipating that their shares will grow in value (capital growth) and they will earn a dividend (income) whilst they hold onto the shares. Whilst this is the case most of the time, it is not a certainty. Many people have lost money on the share market as the value of their shares has dropped. On the positive side, you have very good access to your assets as you can generally sell the shares on the share market within a day.

Property
Compared to the other asset classes, property has a moderate return which is accompanied by a moderate risk. Historically it has been shown that the capital growth in property (about 8.5% pa) is less than shares but so is their risk. Investors and owner occupiers are often attracted to property due to the security that it offers. People can make a profit form holding property if it is the right type of property, is well located and they are willing to hold onto it for a period of time. However, some people have lost money on property but this is generally because they bought the wrong type of property, in a poor location and had to sell when the market was soft. Property buyers generally find that the value of their property increases over time and if they are investors, they also receive income in the form of rent. On the negative side, property has low liquidity i.e. you can’t sell it and access the funds quickly as you can with the other three asset classes.

So, what’s smart investment all about? It’s all about making money and minimizing the associated risk.

So far as property is concerned, it’s about buying the right type of property in the right location.

Happy House Hunting!

Written by Peter Koulizos, university lecturer, author and buyers advocate.

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