There are also other, more complex and less common, methods of gearing. These include:
• Instalment warrants - often used in self managed super funds; and
• Structured products.
The following table illustrates the features of these less common types of facilities.
(1) Lodging additional capital. That is, contributing an additional $20,000.
(2) Reduce the loan amount by $12,000 to $48,000 (by selling down assets). This would bring the LVR to 60 per cent. This option crystallises some of the losses on your portfolio.
Lending facility Benefits Disadvantages Instalment warrants
May be suitable for self managed super funds
• Leveraged exposure to individual or basket of underlying securities.
• Boosted yields via higher levels of dividend and franking credits.
• Generally higher interest and borrowing fees relative to other options.
• Must retain the instalment warrant until the end of the term to be able to own the shares outright.
• It takes time to administer and manage these products.
• Guaranteed not to lose money if the investment falls in value and it is held until maturity
• No margin calls
• Able to borrow up to 100% of the money being invested
• The interest rate is substantially higher to pay for the guarantee
• Only a portion of the interest expenses may be deductible due to the capital nature of the protection
• Strict restrictions on investment options and rules governing the extent of the protection
• Very high break even point to cover high finance costs, usually in the vicinity of five per cent per annum after-tax capital growth
• Some funds may move your money into cash when the markets are experiencing periods of negative returns.
This can limit future growth of your investment.
Whether you are putting aside $2,000 to use in 3 months or saving for your retirement, the things you need to consider before investing are the same. These are outlined over the following pages.
Investing increases the value of your money to help achieve your goals and objectives.
Meeting your objectives
Reasons for investing will vary from one person to another.
Common objectives include saving for a house, managing cash flow, paying for children’s education, creating wealth, saving for retirement or managing retirement income.
Different investments
There are five different asset classes you can invest in: cash, fixed interest, property, Australian shares and international shares. Each has its own level of risk as well as a potential return.
Types of investments
Cash • Cash is the most secure investment. The return you receive will depend on interest rates at the time.
• While cash is very low risk, the increasing cost of living (known as inflation) can decrease the buying value of your money. Tax on the returns should also be considered when working out the real, after tax, return of a cash investment.
• Cash investment can usually be accessed immediately (“at call”). However, if invested in superannuation and pension accounts, legislative restrictions must also be considered. Cash investment offers no growth.
Fixed interest • Fixed interest investments arise from loans. An investor lends money to a borrower who must then repay the loan as well as interest.
• Fixed interest investments differ due to:
• The type of loan issuer,
• The security/asset that backs the debt,
• The loan timeframe, and
• The interest rate.
• Generally, the longer the loan timeframe and the less secure the lender, the higher the interest rate.
• Typical fixed interest investments include:
• Term deposits that provide a regular income at a fixed rate for a set timeframe.
• Mortgage trusts provide regular interest income at variable
rates and a high level of capital security. Investors’ funds are pooled and invested mainly in registered first mortgages secured against a spread of freehold property. Usually only 66% to 75% of the properties value is lent.
• Bond trusts provide regular interest income through pooled investment in Government and corporate bonds. These funds offer high long-term capital security and the potential for some capital growth in addition to interest income.
• Generally you can only access money from fixed interest
investment at maturity. Again, when investing in superannuation and pension accounts, legislative restrictions must be
considered.
Australian shares • Australian shares are investments in companies listed on the Australian Stock Exchange.
• As a shareholder you become a partial owner of the company and therefore benefit from the profit and capital growth the company achieves.
• Investment returns are paid in the form of dividends (a distribution of the companies’ profit) and capital growth (reflecting the increased value of the company over time).
• The upside of growth and profits comes with the risks associated with owning any business, cost increases, regulation changes and increases in competitor presence.
International shares • International shares allow you to become a partial owner of an international company, the same as you would in an Australian company.
• This can offer opportunities that are not available within the Australian share market and provide further diversification to your portfolio as different countries' economies grow at different rates.
• The Australian share market only represents about 1% to 2% of the world share markets.
• Returns on international shares are affected by changes in currency exchange rates.
• While the purchase and sale of Australian shares is relatively easy and the cost to buy Australian shares is relatively low,
Property Residential
• For many Australians, property is their first and most significant investment. Generally property is purchased to meet housing needs, not as an investment to make a profit.
• Some people may also buy a rental investment property. The risks of direct property include interest rate changes, tenant vacancy and property damage.
• Property is an all or nothing investment – you can not sell a room if you need some cash, you have to sell the whole asset.
Commercial
• Commercial and industrial properties generally generate higher rental incomes, however, most people cannot afford to invest directly i.e. buy a whole office building.
• An easy way for Australians to invest in commercial property is through pooled investments such as a managed fund or listed property trusts.
• Property is a valuable inclusion in most people investment portfolios because property values tend to move independently of share prices. Including property in your portfolio can smooth out the overall return on your investments.