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Written by Kris Wrenn – Senior Adviser
Property, shares and managed funds are three of the main types of investment and Hudson Financial Planning have almost 30 years of experience providing advice relating to all three. An investor who wants to spread risk and diversify should consider investing in all three areas.
Property is often the first investment to consider for many investors, because it is generally “larger scale” and if you invest in shares before considering property you may rule yourself out of being able to invest in a quality property. If you invest in property first, shares on the other hand, can be invested into on almost any scale. The key benefit of property is the ability to leverage and as such significantly amplify your returns. Banks are generally prepared to lend for property with as little as 5% or 10% deposit, the usual deposit being 20%. With shares on the other hand, although you can leverage into them using only the shares themselves, the banks may only be prepared to double your exposure, unless for example you use a property as collateral.
Historically property has been one of the greatest assets in terms of experiencing capital growth, with thousands of investors buying property 25 or 30 years ago for say, $100,000, that is now ten times that or more.
It is also a very tax effective investment, due to the vast array of expenses that can be claimed against them to reduce the impact of tax on the income generated. Property can even be “negatively geared”. This is whereby the expenses outweigh the income and as a result your taxable income reduces by the difference and you receive a tax rebate at the end of the financial year.
Choosing what to buy and where when it comes to an investment property is no easy task and seeking advice is paramount to securing a quality investment that will achieve capital growth. Considerations include the level of local amenities, distance to schools and train stations, the desirability from prospective tenants, the “uniqueness” of the property. All of these things impact the demand to live in the property which directly impacts the value.
Shares are another great way to invest. Shares are effectively owning a tiny portion of a company and they can be bought over an “exchange”. Historically the Australian (and most other countries) share market has returned around 10% p/a over the long-term. Most of this is made up of capital growth and partly from “dividends” which are an annual income paid by the company you’ve purchased a share in. The beauty of shares is that you can invest as much or as little as you wish. As with property, doing your due diligence is important and it is equally important to seek advice. It’s also very important to diversify when it comes to shares, because ANY company you buy a share in could, in theory, continue to decline and could eventually go into liquidation and close down. This is known as “company specific risk”.
Managed Funds are a great way to reduce company specific risk. Managed funds are platforms whereby an investment manager pools peoples money and buys many shares, sometimes thousands of different companies. The total value of these shares is reflected by what’s known as the “unit price”. As the shares continue to pay income and continue to rise in value, the unit price rises and the investors portion is worth more. Like shares they usually pay an income, not known as a dividend, but as a “distribution”.
Managed funds usually have a specific focus. They may target a particular country/countries, or they may target a particular sector within a country. They can be actively managed where the fund manager is constantly changing the portfolio, selling down shares they think may decline in value and purchasing shares they think will increase in value. Or, they may be passively managed and may seem to mirror an index. E.g they may purchase the largest 200 companies in Australia (in proportion to the size of the company) in order to mirror the ASX200.
Due to the vast range of options when it comes to managed funds, seeking advice from an adviser is paramount to success. An adviser uses research houses to make sure they recommend fund managers that have a proven history of success. They can also make sure the level of risk is appropriate to the appetite for the risk of the investor and also their situation (age, income etc).
Diversifying your assets and engaging an adviser are both ways to reduce your risk, however the fact is that risks do remain. These include:
Market Risk – investment sectors such as shares and property tend to be cyclical, and the performance of shares, managed funds or property can be significantly affected by the respective market at large.
Fund Manager Risk – the investment decisions made within a managed fund are the direct responsibility of the fund manager. The quality of the decisions made will be reflected in the unit price of the managed fund. As such there is key person risk in this regard, in that key staff and decision makers may resign from their position and no longer assist in running the fund.
Gearing Risk (if funds were borrowed to invest) – Gearing magnifies gains but it also magnifies losses. If the investment returns are less than the gearing costs, the borrower may be unable to service the loan. If so, selling some assets might be required to avoid default and it could be an inopportune time to sell should this occur, i.e. it may crystalise losses.
Legislative Risk is the possibility that a change in legislation will impact the appropriateness or financial benefit of certain investments for your strategy. Legislative risks are inherently difficult to measure, but are commonly related but not limited to the taxation treatment of certain investments.