Customer Education
Superannuation & Investments
Investment fundamentals
The main objective of super is to create wealth so that in retirement you can enjoy a reasonable standard of living. Investing member and employer contributions and accumulating them with investment earnings to build up a pool of assets creates this wealth.
There are a number of factors to be considered when investing, including the types of assets in which to invest, the trade off that exists between risk and return, the reduction of risk through diversification, and the concept of dollar cost averaging.
Asset classes
When choosing to invest there are four main types or classes of assets:
- Cash
- Fixed interest (also called bonds)
- Property
- Shares (also called equities)
This type of investment refers to any deposits in a bank, building society, credit union or cash management account. It will also include investments that are made in the short-term money market. Cash is viewed as being relatively safe compared to other types of investments, and the returns are generally lower than more risky investment classes.
Fixed interestFixed interest securities are mainly bonds which are securities that enable governments, semi-governments and large companies to borrow money. They provide a fixed flow of income and have a fixed capital value that will be repaid at a set date to the holder of the security. The value of bonds change with movements in interest rates. As interest rates rise, the value of bonds will fall and vice versa. These fluctuations are why bonds are seen as a more risky investment than cash and, over time, they may provide a higher return than cash.
PropertyThis class of investment can be in retail, commercial, industrial, rural, tourism, or residential property. Property for investment can be either direct or indirect. A direct purchase is when an investor makes an outright purchase of land or buildings, and the valuation of such an investment will be determined periodically. An indirect investment will be made through a listed property trust on the stock exchange or through an unlisted trust. A listed property trust has its value determined by the market. The value of unlisted trusts are determined when properties are valued.
SharesShares represent part ownership or equity in a public company, which is listed and traded on the stock market. If a company prospers, then shareholders will benefit from a share in the profits (dividends) and/or any rise in the market value of the shares. The value of shares tends to fluctuate and are, therefore, considered a more risky option than cash, bonds, or property. However, over time, shares have generally offered higher returns than the other asset classes.
Risk and return
The risk of an investment is the probability that the return for the investment will be different from the expected return. While the return can be higher or lower than anticipated, there is a possibility that an investment may earn significantly less than anticipated. As there is no optimum level of risk, each individual investor must determine what is an acceptable level of risk to suit their circumstances.
One of the most important concepts in respect to investment risk is the risk-return trade off. Although it is not a precise relationship, generally the higher the level of risk associated with an investment the higher the potential return. It is important, however, to understand the level of risk that is associated with achieving the return.
The risk associated with an investment is often referred to as the volatility of the investment. The more volatile an investment, the higher the fluctuations experienced in the investment return. It has been shown however that, generally, investments that are higher risk and more volatile have a higher return over the long term.
This is illustrated in the following table:
|
Cash |
Bonds |
Property |
Shares |
Volatility |
Low |
Moderate |
Moderate-high |
High |
Returns |
Low |
Moderate |
Moderate-high |
High |
Timeframe (yrs) |
1+ |
3 - 5+ |
5+ |
5 - 7+ |
When developing an investment strategy there are a number of risks that will need to be considered. These types of risks will include:
- Currency risk - When investing in overseas securities a rise or fall in the value of the Australian dollar could possibly either reduce or increase the level of return. A weaker dollar will increase the value of the overseas investment, while a stronger dollar will have the opposite effect.
- Inflation risk - An investment’s real value may reduce with an increase in inflation rates.
- Interest rate risk - An increase in interest rates may possibly reduce the value of a bond investment.
- Manager risk - There is a possibility of a fund manager not achieving the fund's investment goals objective.
- Market risk - Over short or long periods there is a possibility that shares, listed properties, or bond values will decline.
How diversification reduces risk
One way in which to reduce the risks associated with investing, and help smooth returns, is to diversify your investment, reducing the risk of ?placing all your eggs in one basket?.
Diversification is achieved by combining different kinds of investments (ie different asset classes, different investment managers and/or different sectors) as part of your investment strategy. By diversifying your investments you may decrease (but not eliminate) your investment risk.
The TOWER multi-manager, diversified investment options provide diversification by offering a mix of investment managers, asset classes and investment styles. The single manager, single sector investment options do not provide the same level of overall diversification.
Dollar cost averaging
The principle of dollar cost averaging is investing small amounts at regular intervals so that the highs and lows of the market will become less important. When investing at a regular interval (ie monthly) you will buy less when the market is high and more when the market is low, and so over time the purchase value will even out.
An example is shown below of investing in a managed fund, and the investment is $100 per month at an initial unit value of $8.
Month |
Investment |
Unit Value |
Units Purchased |
1 |
$100 |
$8 |
12.5 |
2 |
$100 |
$10 |
10 |
3 |
$100 |
$8 |
12.5 |
4 |
$100 |
$5 |
20 |
5 |
$100 |
$8 |
12.5 |
6 |
$100 |
$10 |
10 |
Total |
$600 |
$8 (average) |
77.5 |
At the end of 6 months there is 77.5 units that have cost you a total of $600 to purchase, an average of $8 each unit. This compares to a potential cost of just $387.50 if you invested in month 4 or $775 if you invested in month 2.
