Factors affecting investment decisions

Diversification: is where the asset allocation of the total investment portfolio is distributed among shares, property and interest-genarating assets. By diversifying one's portfolio, this has the benefit of reducing volatility of income earnings and capital growth from the total portfolio whilst providing a more consistent and reliable income stream. Once a balance between the different asset classes are set, retaining that balance usually requires going against cycles of individual assets. This means that investors may sell some of the assets that are performing well whilst purchasing assets that are generating lower returns with the goal of maximising long-term returns.

Direct Investment vs. Managed funds:

Investment in each of the four asset classes can be undertaken in a number of ways including,

• direct investment

• geared investment

• indirect (managed) investment via

– superannuation – wholesale unit trusts via a master trust

– retail unit trusts – insurance bonds/friendly societies.

Direct investment is when investors choose which asset class is suitable for allocating their funds over the period of time under that payment. Depending on the choice made there are varying levels of expertise required by investors to ensure a balance portfolio is maintained. Investors need to take into account diversification, risk, liquidity and asset cycles as well as monitoring the market on a daily basis. However, very few investors have time or expertise to personally manage a diversified portofolio of direct investments. As well it is difficult to achieve a sufficient spread of investments which causes the risk associated with the investment to increase.

Managed funds is an indirect investment. These investments are formed from funds pooled by many investors and are managed by a professional investment manager. Managed funds can accept varying investment levels of investors and returns are distributed in proportion to the amount invested. The majority of difficulties for the investor can be removed by investing in managed funds as these funds offer access to fund managers who have experience, knowledge and resources to continuously monitor and mange portfolios as well as having access to research and statistics. However, these funds come at a cost since each managed fund has its own fee structure and this cost must be taken into consideration before choosing to invest in a managed fund.

Time frame:

Once strategic plans and investment decisions have been made, then the time frame of your investment will contribute significantly to your decision making. In general there are short, medium and long-term time frames.

Short term: is between six months to two years which are usually interest based and include bank term deposits and cash management trusts. These types of investments are not subject to fluctuations and attract those who want an easy access to their funds.

Medium term: is between two to five years where it allows some room for fluctuations in investment values hence, these investment can provide some capital growth on top of income. Some medium term investments include shares, listed property trusts, mortgage trusts and bonds.

Long term: more than five years, it includes medium term investments as well as insurance bonds and real estate. Any costs associated with accessing these investments are less significant when they are spread over more than five years.

Risk:

In general, investments with high potential returns and losses are associated with high risk whilst low risk investments provide potentially lower returns and losses. Money and fixed-interest investments are income generating investments and therefore are considered to be low risk investments. Contrary to this, growth assets such as shares and property investments are considered to be high risk and thus attract higher potential returns and losses. However, it is important to note that no single investment or asset class is totally risk free. One method of limitng risks is to have a well diversified investment portoflio of quality assets. Thus, choosing the right investment for funds requires making a selection from the four classes of assets and this will take into account all factors that affect the growth of the investment.

Taxation:

Interest earned on cash or fixed interest deposits attract a tax liability for th investor. As well, dividend from shares may attract taxation depending on the type of divdiend. However, if the dividends are franked dividends then no tax liability for the investor exists whilst dividends that are not franked attract a tax liability for the investor. Additionally, capital gains occur when an asset held by an investor increases in value over a period of time and are realised (usually being sold) at a point in time. The capital gains tax (CGT) may be payable on that portion of the increase in the value of the investment above the consumer price index (CPI).

Changes in the purchasing power of the dollar:

Inflation is an increase in the general level of prices. The consumer price index (CPI) is the tool used in Australia to measure the general change in prices over time. When there are rising prices (inflation), the purchasing power of money decreases. Inflation disadvantages savers and lenders as the values of savings and debt remain fixed while prices rise and thus the real values of those savings and debts decline. On the other hand, spenders and borrowers are at an advantage.

Comparison and analysis of the performance of an investment portfolio:

The return on the four asset classes should be compared over time which can be done by developing a spreadsheet and graphing figures.

This spreadsheet can be used to compare the volatility of each asset classes. In this example, it is clear that overseas shares is the most volatile.

(Source: Accounting Concepts and Applications 4th edition, Phillipa Greig, Joan Mackay, Stacey Beaumont, Rosette Sanger, 2008)