Question 4
Question 4: I have recently inherited $250,000 from a relative. Could you please outline the investment options that are available to me and their associated levels of risk? I have also been told that I should consider diversifying my investments but I'm not sure if I quite understand what this means. Could you please explain in simplified terms? What investment recommendation would you make and why?
A. There are 4 main asset classes in which you could invest in: cash, fixed interest, property and shares.
Cash: This includes investments such as bank deposits. Cash is considered a short term investment with high liquidity and low risk. It is a short term interest rate with no capital growth.
Fixed interest: This includes government bonds and debentures. It is a medium to long term investment with moderate liquidity and low to high risk (government bonds have low risks), it is a fixed interest rate income with potential for capital gains and losses due to interest rate changes dependant on when it is sold.
Property: This includes residential, commercial, industrial and retail property. It is a long term investment with low liquidity and medium to high risk. The income received is rental returns as well as possible tax savings through negative gearing. As well there is potential for capital gain and losses.
Shares: This is a medium to long term investment with high liquidity if it is listed on the ASX (stock exchange) but low if it is not listed on the ASX. It is of medium to high risk depdning on economic conditions and he income generated is through dividend distribution as well as gearing and tax-effectiveness if dividends are franked. There is potential for capital gain and losses.
Diversification is where asset allocation of the total investment portfolio is distributed among shares, property and interest-generating assets. By diversifying your portfolio this has the benefit of reducing volatility in income earnings and capital growth from the total portfolio whilst giving a more consistent and reliable income stream.
It is recommended in your situation to invest in a low risk investment such as through cash or fixed interest. However, in order to diversify your portfolio you should look into investing through managed funds as it allows you to invest in the 4 asset classes whilst having the investments managed by a profession investment manager. The majority of difficulties that investors have 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 manage portfolios in addition to having access to recent research and statistics.
(Source: Accounting Concepts and Applications 4th edition, Phillipa Greig, Joan Mackay, Stacey Beaumont, Rosette Sanger, 2008)