We take $20,000 and put it through a five-year investment test to see how much you would have made in the past five years, writes Margie Sheedy.
Imagine you were given an investment crystal ball. Suddenly, all the educated guesswork that goes in to finding the best return for your money would be as easy as asking your ball, “Where should I invest my spare cash?” And voila! Your answer sits in front of you.
The problem is that there are so many different types of investments to choose from: corporate bonds, term deposits, government bonds, shares, and property. And that’s before you get into more complicated investment strategies.
So to help you out until you find that elusive crystal ball, we asked Brian Parker, MLC Investment Management Investment Strategist, to crunch some numbers on the advantages and disadvantages of an array of different types of investments. Take a look at this advice: it might be the best present you get this year.
Where to start
Doing a lot of research is paramount in the investment process. The more information you have, the wiser you will be when you’re looking for places to put your hard earned savings.
The Australian Securities Exchange has a raft of educational resources for beginner and advances investors. You can even do a free ASX shares online course which runs through everything from the risks and benefits of shares to record keeping.
Brian Parker says it’s imperative that you know how an investment works before you put money into it.
“What is it about that investment that entitles you to a return?” he asks.
“You need to be fully aware of, and be comfortable with, the risks you’re taking.
“If the investment does well, how well could it go? And perhaps more importantly, if it goes pear-shaped, just how pear-shaped could it go?
“If anyone promises you high returns and even implies that those returns can be achieved with total safety, run a mile and fast!
“You also need to understand that there will be periods of time where some investments will outperform others and this is why it’s important to have a diversified investment portfolio.”
For Parker, the best place to start your swim into the swell of investments is to get some advice.
“Sit down with a professional adviser and discuss the financial and lifestyle goals you want to achieve, what kind of returns you need to get to where you want to be, and how much risk you’re prepared to take to get there,” he says.
“Really understanding your tolerance for risk is critical. There’s no point chasing higher returns and higher risks if you can’t sleep at night.”
If you had $20k to invest…
We gave Brian Parker the following scenario so that we could compare the different investment strategies, not on their future promise but on how they would have performed over the last five years. For each investment type listed below, we asked: if we had sunk an imaginary wad of $20,000 in that particular investment type, how much would we have now? Check out the returns.
Bond markets have performed well over the past five years as investors have sought out the safety of high quality government bonds but also corporate bonds.
“For Australian corporate bonds, $20,000 five years ago is worth nearly $30,000 today, assuming you’d re-invested all the interest payments along the way,” says Parker.
Pros: “For corporate bonds, the pros are that you get higher yields than you get from government bonds.
Cons: “The cons are that you’re taking on higher credit risk – if the company goes bust you probably won’t get all your capital back.
The best defence against this is to be really well-diversified; have exposure to a range of different companies and securities. For small investors, it’s hard to get that diversification, which is why a managed fund makes a lot of sense in this space.
If you had invested $20,000 in this investment option five years ago, “Well, you would still have your $20,000, but you’d have enjoyed quite attractive interest rates along the way,” says Parker.
“Three years ago, term deposit (TD) rates were around seven per cent, which proved very attractive to a lot of investors, especially after the pain of the GFC,” he says.
The problem is that today, those TD rates are now closer to 4.5 per cent, which means investors are getting something of a shock when they roll over their term deposits.
Pros: “Term deposits with a bank are a safe option, with a known result,” says Parker.
Cons: “The main negative is that your money is locked away for the term.”
“Over the last five years, your $20,000 in Australian government bonds is now worth close to $30,000,” says Parker.
Government bonds are relatively safe: the government pays you interest every six months and pays you back the face value of the bond on maturity.
Pros: “The chance of the Australian government not paying you back is extremely remote,” says Parker. “Bonds also usually provide excellent diversification for investors because they tend to do well in times of market turmoil and the last five years have been a classic example of that.”
Cons: The cons are that over the longer term returns tend to be lower than returns on shares, property or corporate bonds. “And today, the yields you’re getting on government bonds are very low,” he adds.
Even though we’ve seen better returns in the past year, the five-year returns from Australian and global shares have been “very poor”..
“In Australia, your $20,000 is now worth just under $17,000 assuming you’ve reinvested the dividends along the way,” Parker says.
Pros: “Over the long-term, shares tend to perform better than either bonds or property,” notes Parker. “Ultimately, you’re investing in the businesses that make up the Australian and world economies, and those businesses in aggregate tend to grow in value over time.”
Cons: The downside of shares is that they can be very volatile and can sometimes produce very poor returns for periods of time.
“As a share investor, you need to be well-diversified, be comfortable with shorter term volatility and be prepared to think of your share investments as a long-term proposition.”
As the old saying goes: “location, location, location”. Returns on a property investment over the last five years were largely determined by where a buyer invested.
“Parts of Australia have gone backwards during the past five years and other parts have performed really well.
Pros: “Property values do tend to grow over time and residential property does provide some diversification benefits.”
Cons: The negatives are that it’s hard to get a well-diversified portfolio unless you have serious money to spend.
“Having a big chunk of your portfolio tied up in one or two properties in one city isn’t great diversification. Also, it can be difficult to sell a property if you decide you need money. Costs can also be substantial, from property management fees to stamp duty.”
Margie Sheedy is the author of The Small Business Success Guide (published by John Wiley). More information on her book is available through her blog, Small Business Success.