Why everyone needs to invest
Your first exposure to the discipline of saving may have involved squirrelling away pocket money to buy that new bike when you were a kid. In hindsight, you were demonstrating one of the time-honoured pillars of goal-based investing, and hopefully these good savings and budgeting habits have stayed with you.
Times have changed, but the rudiments of saving still begin with the simple act of putting away more money than you take out. While all financial literacy starts with this simple principle, too many Australians still struggle to cross the Rubicon from good saving habits to consciously investing their money.
Leaving your money in a savings bank account (earning 0.09% interest) is a form of investing. But in the truer sense of the word, investing is more about putting your money to work in the market – into a mix of assets like property, shares and term deposits/cash - where a perfect storm of capital growth, income (aka yield) and compounding returns will accelerate your wealth over time.
Investing is for everyone
The compulsion to invest is typically motivated by an individual’s financial goals. Whether your plan to buy a new car, save for your first home or the kid’s private education - or simply have cash reserves for unexpected life events - you’re going to achieve these goals faster if you have a road map for getting there.
While it doesn’t have to be sophisticated, this road map is the investment strategy you decide to take to help grow your money. The principles of investing are universally applicable, regardless of whether you’re new to the workforce, already have a portfolio of assets or sit somewhere in between.
While there is no one-size fits all approach, the act of investing to achieve good rates of return - by growing the value of these assets – helps you achieve your personal goals, while also taking the guesswork out of making financial decisions.
Know thyself first
But before investing with your ears pinned back, there are a few things you’ll need to understand first. For starters, you need to have an accurate picture of your current financial position, and this is where a simple budget outlining income and outgoings can help.
Secondly, you need to fully understand what your financial goals are, and if you don’t, it’s time for some soul-searching. Once you’ve done this, you can then assess over what timeframes you plan to achieve these goals. This will go a long way to clarifying what your risk profile looks like, which in turn, helps to determine what spread of defensive and growth assets is right for you.
Investing gets a couple into their first home faster
Here’s how Sydney-based millennials deployed the power of diversification, and compounding returns to achieve their home deposit a lot earlier.
Millennials, Brittany and Caleb Martin* wanted to save a 20% deposit for an apartment in Glebe. Their goal was to save $140,000 as soon as possible, and at the time had already amassed $15,000 in savings. They were also able to save an additional $690 a month.
Being overly cautious about capital loss, Brittany and Caleb initially favoured a bank term deposit. While the interest rate was low, they liked the idea their money was government guaranteed. But based on an interest rate of 1.9% it was going to take almost 13 years to save $140,000.
They feared that rising house prices would push their 20% deposit progressively out of reach. A friend who’d faced the same dilemma suggested to Brittany and Caleb that an InvestSMART Balanced Portfolio was a better alternative to a term deposit.
Diversification blends out the risk
Instead receiving a 1.9% return in the bank, the InvestSMART Balanced Portfolio would invest their initial $15,000 and additional $690 a month in a blend of low-cost Exchange Traded Funds (ETFs). While past performance is no guarantee of future returns, Brittany and Caleb were encouraged to learn that the InvestSMART Balanced Portfolio had returned 7.47% in the six months to 30 September, and 5.25% since inception.
The Martin’s realised that achieving better returns through ETFs carried greater exposure to risk than a term deposit. But on closer analysis, they also recognised that the even allocation across defensive income assets (bonds and cash) and growth assets (shares and property) within the InvestSMART Balanced Portfolio would successfully mitigate much of that risk.
Assuming fund continues to deliver historical returns, Brittany and Caleb are on target to achieve their $140,000 20% deposit by November 2030 - three years earlier than had they kept their money in a term deposit.
The tale of two pre-COVID investment strategies
Peta and Mandy Roe* were each left $250,000 by their grandmother in March 2020. While both granddaughters quickly invested their windfall, the investment choices and their outcomes have been diametrically different.
a. Property investment sours
Peta used her $250,000 to buy a $450,000 villa at Southport, and took out a loan for the rest. Based on a $200,000 interest-only loan for five years, she had to pay $867.000 in monthly mortgage repayments.
After factoring in weekly rent of $420, and monthly property management fees of $90, she expected to be left with $723 in monthly positive cash flow.
After receiving five weeks of rent, COVID hit, and Peta’s tenants did a runner after losing their jobs. Unable to attract other tenants, Peta continued to cover her mortgage out of savings, rather than put her mortgage on hold.
By August Peta no longer had any cash reserves to continue servicing the mortgage. With no other options available, she was encouraged to sell and cut her losses, even though the median house value for the area had fallen 20%.
Peta finally sold the villa for $360,000, $90,000 less than she’d paid.
After factoring in $15,200 in mortgage payments, property management fees, maintenance/insurance and repairs, plus 2% in agent’s commission, Peta was left with only $144,800 of her original $250,000 inheritance.
b. Conservative strategy weathers the COVID storm
Being conservative by nature, Mandy was comfortable with a lower returns from the investment of her $250,000 inheritance in return for less risk. A friend suggested she look at the investment options on the InvestSMART website, and after reviewing their ETF portfolios, she decided that the Interest Income portfolio best suited her needs.
In the six months to 30 September, the $250,000 Mandy invested in the InvestSMART Interest Income portfolio had grown to $252,031. In hindsight, Mandy is grateful she didn’t listen to her sister and buy an investment property earlier this year.
In light of COVID, she’s also grateful that the money her grandmother left her remains intact, and completely incubated from the volatility of growth assets like property and shares. Equally encouraging, Mandy knows that returns from the Interest Income portfolio will improve along with the economy, with total returns from the fund being 3.17% since inception.
*Name changed for privacy reasons