Ownership rules
Annette Sampson, Sydney Morning Herald, 7th of February 2006
It's never too late to start investing. Even with a modest salary you can build and accumulate wealth, reports Annette Sampson.
Think you're not flush enough to be an investor? Think again. A 30-year-old earning $30,000 today stands to earn $2.7 million by the time they're 55, if their pay increases by just 5 per cent a year. That's just a bit more than inflation. If you're 40 and earning $40,000, you should earn about $1.9 million by the time you're 55, using the same assumptions.
Much of that money will go in tax and living expenses but history has proved it's not how much you earn that determines your long-term wealth, it's what you do with it.
As the head of IPAC Financial Planning, Sally Manion, points out, there's a good reason that buying a home works so well for so many people. And no, it's not just the fact that house prices have had a good run. Manion says home ownership is a great wealth creator because it forces people to save regularly by making mortgage repayments.
Problem is, if you're not locked into a mortgage - or if you've already paid yours off - most people tend to spend that extra cash, rather than putting it to work in other areas.
The good news is that even if you have only a small amount of cash, if you're prepared to use the same discipline that you would to pay off a mortgage, creating wealth is a fairly simple process.
There are even investments tailored for investors with small amounts of money and if you reinvest any income you earn from your investments, the mechanics of compound interest will ensure your savings grow.
Preparation
Eddie Delacruz, a senior financial adviser with ING Financial Planning, says the first step is to set your goals. With the best will in the world, you're unlikely to get far without motivation, so you have to know what you're saving for.
It may be a short-term goal, such as saving for a holiday or home deposit, or it may be longer-term, such as saving for children's education or retirement.
Manion says it's smart to set short-term targets and to celebrate achieving them. "One of the challenges of long-term investing is putting money away and feeling you're never getting anywhere. You need to feel good about achieving certain targets," she says.
Delacruz says your goals will also form the basis of your investment plan. If you are saving for a short-term goal, for example, you won't be able to commit to a long-term investment strategy. Even investing in shares is a risk because, if the market falls, you may need to sell before your investment recovers.
Think about how long you're prepared to commit to saving and don't forget to allow for contingencies. If you haven't done one already, Shannon Henry, a financial adviser with DHW Financial Services (a company accredited by AMP Financial Planning), suggests doing a budget to work out how much you can afford to set aside each month.
But don't get over-enthusiastic, warns Manion.
"You have to balance your enthusiasm with reality," she says. "The danger is that you may hone your investment strategy so tight that as soon as you need to breathe it will fall apart."
Manion suggests you start by putting some of your designated savings into a short-term savings account rather than committing the lot to long-term investments, until you get an idea of whether you can afford to save that much, or whether you're leaving yourself short. If you find you can live on the budgeted amount, you can then transfer the saved cash across.
Manion says you should also provide for tax on your investment income in your cashflow analysis.
"You have to ensure you have a cash reserve so you don't have to draw down on your investments," Delacruz says.
"Cash flow is the key to any investment strategy."
How Much Risk?
Do you want to keep your money safe or do you want to shoot the lights out? The bad news is you can't do both at once.
"Lots of people want to outperform inflation but they don't want negative returns," Delacruz says. "They don't realise the two contradict one another." As a general rule, you can take more risk if you're investing for a longer period, as you'll have time to ride the market ups and downs.
Marissa Broome, a principal with wealthadvice.com.au, says you probably need to commit to at least seven years if you want to invest in so-called growth assets such as shares and property - particularly if you're looking to borrow to enhance your returns (and risks).
A financial planner can be useful here in helping you understand the risks you're about to take, but take the time to think about how much risk you're prepared to accept to achieve your returns ,even if you're not using a planner.
Delacruz says anyone with super has first-hand experience of market ups and downs, with super fund returns fluctuating from negative figures to double-digit returns over the past four years.
How did you feel when your super fund was going backwards? Are you prepared to accept that sort of volatility with your other investments?
As a rough guide, Henry says, an investor in a balanced portfolio (with about 70 per cent in growth assets), can expect a negative return every four or five years. But if you want to be more aggressive, you'd probably be looking at losses in one out of three years.
When markets are running hot, there's a real temptation to chase high returns - such as those currently being generated by many resource stocks. But Henry says you should ask yourself whether you're prepared to lose the lot.
If you aren't, she says, it's best to stick to a diversified portfolio - though some investors allow themselves a small amount of "funny money" that they can afford to lose for such gambles.
Where To Invest
Your investment options will depend on your goals, time frame and risk profile. Your options will also expand as you have more money to commit. (See boxes.)
But even if you're just looking for a short-term place to park your savings, Broome says you should set up a separate account and organise for a set amount to be transferred there each month.
Your employer may agree to put part of your salary into a different account, or you can arrange for an automatic transfer from your main bank account.
Henry says her advice to first-time investors is to set up three accounts - an everyday transaction account for your daily finances, an emergency account such as an online high-yield account and the account/s for your investment strategy.
She says one of the golden rules of long-term investing is to diversify your investments. While many people start off investing by buying one share, millions of Telstra investors can attest that this is a risky strategy - even when it is a so-called blue chip investment.
By having a mix of investments, you spread your risk so that if one investment goes bad, you don't lose your dosh. You can take on more or less risk by increasing or reducing your exposure to growth investments.
"Asset allocation [deciding on the mix of growth and conservative investments] is the biggest driver of investment performance," Delacruz says.
Structures
You should also consider what investment structures you will use. Do you want to invest directly or do you want to go into a fund where someone else makes the investment decisions for you?
Direct investments, says Delacruz, give you more control over what you buy and sell and when, which also means you have greater control over when you incur capital gains tax. The downside, he says, is that you need to develop expertise to make these decisions and you also need more money to diversify.
For example, he says you'd probably need to hold shares in 15 companies to be diversified across the main industries in the sharemarket.
Diversification is where managed funds come into their own. Even investors with
just $1000 can invest in a fund that offers a wide spread of investments.
Henry says a typical Australian share fund will give you access to 100 to 150 different stocks, while balanced funds give access to other asset classes, such as fixed interest, cash and property, as well. But you lose control - both over what you invest in and the tax consequences.
Other managed options include tax-paid investments such as insurance bonds and even super.
While super is strictly for the very long term, Broome says it offers big tax advantages. If you're on a low to middle income you may be eligible for the super co-contribution (where the Government matches part or all of your super contribution) and higher income earners can get tax advantages by asking their employer to put part of their pay into further super contributions.
"You have to ask where you see the role of super in your portfolio," Manion says.
"You may want to put the more aggressive investments into super because it has to stay there long-term and if you're ever going to need to undo anything it will be your non-super investments."
Broome says you also need to consider what happens if you want to change your investments. This is where products offering access to a range of investment funds and managers (such as wrap accounts) can help as you can switch between funds within the one overall investment structure.
The discipline
Most managed funds now come with savings plans where you can automatically invest another $100 or more a month.
"It makes sense because it gives you discipline," Delacruz says. "Once a savings plan is up and running, people tend to let it run."
Manion says investing regularly also gives fabulous dollar cost averaging. This means that by buying investments regularly, you buy through both ups and downs in the market, which reduces your chances of buying at the top and losing money.
If you're investing direct, adding to your investments requires more discipline and small purchases tend to not be worth the transaction costs. But you still need a strategy for adding to your investment regularly - maybe by transferring a set amount each month to an online savings account until you have enough to invest.
Time to accelerate?
If you have a secure income and an appetite for risk, you can accelerate your wealth creation by borrowing to invest. Of course, if your investments go backwards, gearing can accelerate your losses too, and for this reason most advisers only recommend it as a longer-term strategy.
Manion says she generally recommends first-time investors start slowly. They may want to commit to a savings plan for a year and learn more about their investments before borrowing to invest further. Or they may choose to put part of their cash into a savings plan and commit to a smaller level of gearing to build up confidence.
The introduction of instalment or regular gearing means you no longer need a sizeable lump sum (or investments that you can put up as security) to start gearing. These plans allow you to contribute a few hundred dollars each month and have that matched (or a proportionate amount advanced) by the lender.
Delacruz says these plans can be useful because they are a disciplined way in which to build your investments - so long as you're comfortable with the risks. Broome says it's essential to check the costs as some plans can be expensive.
The alternative to regular gearing is to borrow a one-off lump sum, either against your home or against other security. Manion says it's often better to build up equity in your investments first so that you can reduce your borrowing levels as a proportion of your portfolio. This will give you a better buffer if markets move against you.
Ongoing homework
Delacruz says it's important to review your portfolio regularly. "You have to review your circumstances, changes in markets, and possible changes in legislation that may affect you," he says. "We'd recommend you do that at least once a year."
Making A Meal Of Buffet
Paul Goudie, a senior marketing executive (pictured above), can thank the US investment guru Warren Buffet for motivating him to start an investment portfolio.
After reading The Essays of Warren Buffet, Goudie says he realised that wealth creation was really a straightforward process.
"[The book] demystified it for me," he says.
Like many young people, Goudie (now 33) says he spent most of his 20s spending his salary. More recently he was starting to think of putting his money to work for him.
He was contemplating buying an investment property but a friend recommended that he see a financial planner.
Through IPAC Financial Planning, Goudie invested his "property deposit" in managed funds. Twelve months later he is sitting on a 20 per cent profit, thanks to the booming sharemarket.
He chose managed funds to take advantage of other people's knowledge, he says. "I also wanted to execute quickly. I saw friends looking in the property market for up to 12 months before they found something but once I had my financial plan my funds were starting to earn good returns immediately."
As well as investing his initial lump sum, Goudie contributes what he would have paid in mortgage repayments to a regular savings plan. While he has the income to gear, he says he chose to play it conservatively for the first 12 months in case he decided to get into the property market. He is now in a position to either buy a property (with a bigger deposit) or increase his investment plan by gearing.
He says managed funds give him greater liquidity than a property investment and he also likes the fact that he can review his performance in real time.
"It costs very little to seek out advice," he says. "You don't need a certain amount of money to get started. Taking the first step is critical because you keep putting it off.
"If I hadn't been referred to a planner I may have bought a property off the plan with very little knowledge and ended up taking a much greater risk."
What I Could Do With ... $1,000
With a small amount, you're better starting with a single investment and committing to add to it.
Marissa Broome, of www.wealthadvice.com.au, says she'd recommend an online savings account for more conservative investors and a managed investment such as a managed fund or insurance bond for those looking longer-term.
A balanced fund can provide access to shares, property and more conservative assets.
Alternatively, says ING's Eddie Delacruz, those looking for a more aggressive (higher risk) investment could choose a sector specialist fund, such as one that invests solely in shares.
With brokerage at about $30, direct shares are expensive if you only have $1,000 - and you'd be increasing your risks through lack of diversification.
Only a small proportion of managed funds accept initial investments of $1,000 but Delacruz says some fund managers with higher minimums will accept investments of $1,000 so long as you commit to a regular savings plan.
Broome says super may also be a good option, especially if you're eligible for the co-contribution.
What I Could Do With ... $10,000
Broome says short-term investors could consider products such as online savings accounts and term deposits, while longer-term investors could look at a couple of managed funds - perhaps through a so-called mini-wrap, which packages funds
for smaller investors.
Delacruz says while the fees on many wraps will be prohibitive, most managers now offer platforms where investors can access a range of funds and select ones appropriate to their needs.
Shannon Henry, of DHW Financial Services, says $10,000 is still on the low side for a diversified share portfolio, although if you're able to add to your holdings, it may be enough to get started.
Instalment gearing may be an option with $10,000 but Broome says she wouldn't generally recommend other types of gearing because most margin lenders have minimum loans of about $30,000 - which would give you too risky a borrowing level.
Super is an option if you're looking long-term and can benefit from either the co-contribution or salary sacrifice.
What I Could Do With ... $100,000
With $100,000 your options are significantly expanded and you have the capacity to tailor your investments - perhaps by using a mix of sector specialist funds rather than a balanced fund, or mixing direct investments and managed funds.
Even if you want to keep your money safe, Broome says with six-figure portfolios you need to include some growth to ensure your money doesn't lose its purchasing power.
As well as products such as online accounts and cash management trusts, Henry says you may want to include things such as quality mortgage funds in a conservative portfolio.
ING's Delacruz says more aggressive investors may choose to include higher growth investments in the mix, such as small companies or emerging markets.
Gearing is also a viable option, though IPAC's Sally Manion says cash flow is still critical.
With $100,000, you could also consider larger investments such as direct property - though you'll still need to ensure you have enough liquidity. Broome says that with fewer investors in the market, demand is increasing for rental properties.
Manion says super has merit for larger investors because of its tax benefits.
