Basic Principles of Investing

The Vanguard Group completed thorough research on the importance of asset allocation to the variability of returns. Surprisingly, around 88% of the variation in the returns of a broadly diversified portfolio resulted from the choice of asset class. Things like ensuring you time the market correctly and picking the right stocks, had a minimal impact on the variability of returns over time.1

So what does this mean? It means that it is very important that we get the asset allocation correct. The individual stock choice is not as important when investing in diversified portfolios. Our questionnaire will ensure you have the right investment portfolio, given your risk tolerance and level of returns you desire. Answering the questions as honestly as possible will ensure we offer advice tailored for you.

Diversification

Picking individual stocks is a difficult job to master. Most do it poorly, and the few that can do it well, usually struggle over a long period of time. I mean, we would love to have bought shares of Apple in the mid 90’s and made a fortune. But I don’t have a genie that can foresee the future, and chances are those who pick stocks don’t either. Some get lucky, some have the skills to do it, but for everyone else – investing in a diversified portfolio is best. Although buying Apple 30 years ago would have been nice, there is another 50 stocks we’re glad we didn’t buy. Whenever it comes to investing, there’s always a chance of losing money. Any company, at any time can shock the market with an announcement no one was expecting.

“Don’t look for the needle. Just buy the haystack.”

We believe the best way to invest is buying hundreds or thousands of securities at a time. This may sound impossible and unrealistic for someone who doesn’t have countless spare hours every day. However, this can be done through an exchange-traded fund (ETF). An ETF is a diversified group of stocks or bonds all packaged together. There are numerous types of ETF’s – some might buy underlying securities to mimic the returns of an index, others may have exposure to specific industries, or some may stick to emerging markets. There are actually hundreds of different ETF’s listed on the ASX with many different underlying portfolios. You can buy the ETF like you would a normal stock, and therefore you can by hundreds or thousands of securities within a few clicks.

How Inflation Can Erode Your Savings

Most people have heard the word inflation – but what effect does it have on your hard-earned savings? Inflation is a term used to reflect the rise in prices for an economy - if inflation rises by 2% per year then something that cost $100 will be $102 the year after. So, if my bank account is giving me a 1% return on my savings, what does a 2% rise in inflation mean?

The Reserve Bank of Australia’s target inflation rate is between 2-3%. In the graph above we have assumed the lower end of 2% (which means that the real deterioration of savings would actually probably be greater). Currently banks are offering about 1% interest on savings accounts. As shown in the graph, you can see the deterioration of $100,000 compared to inflation over time. This means that people who save their money in a bank are actually losing money in ‘real terms’, because the rate of inflation is higher than interest rates. Over longer time periods, this can be detrimental to your savings which you have worked so hard for.

The graph highlights the importance of investing. Over 30 years, $100,000 has grown to $540,000. This was assuming the savings were put in a portfolio with a growth rate of 6% per year - which is a fairly conservative estimate. This is hugely different to sticking the money in a bank and hoping your bank will raise interest rates. Obviously the investment portfolio won’t be growing at a smooth rate like that in the graph. But, the overall trend of holding a diversified investment portfolio for a long period of time will most likely look to be something similar.

Frequently Asked Questions

We would recommend using our budgeting tool to give you some indication on ensuring you will have enough money for the day you retire. However, planning for your retirement is a complex process. Planning for retirement entails many non-monetary based decisions. Answering the following questions would be a good place to start: 1. What type of lifestyle do I want to live in retirement? 2. How much will this lifestyle cost per year? 3. How much do I currently have in my superannuation fund, and how much am I likely to have by retirement age? 4. Do I have more than one superannuation fund and should I consolidate them? 5. Is it worth putting more into superannuation now, but still staying under the reasonable threshold? 6. Will I have any large debts outstanding? (i.e. mortgage, car etc.) 7. Will I be helping pay off someone else’s expenses? (i.e. daughter going through University etc.) 8. Do I want to go on holidays periodically? 9. What other income sources will I have and how much will I earn from them? (ie investment property, owner of a business, shares etc.) Although it is possible to plan your retirement by yourself, we don’t recommend it. We suggest speaking to an adviser when it comes to something as important and complex as your retirement. An adviser will give you the clarity and peace of mind you need when making these critical life decisions.

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