Turning your business into a success is only half the battle. Failing to make the most of the value and wealth your business generates, completely undermines the blood, sweat and tears required to extract value from your business.
Business owners/managers spend so much time providing value to customers, that they often overlook the importance of nurturing the product of this success, their personal wealth. Given the energy required to build your business, spending a little effort to manage your personal investments could make your business and personal journey far less painful in the future.
This article provides some basics theory to assist you on your investment journey. If you knew nothing about investing, this article is a very good place to start.
Risk & Return
Like your business, the parameters governing any investment decision are that of risk and return. Low investment risk usually means low investment returns. As investment risk increases, you require a greater return to compensate you for the additional risk.
The adage, “don’t put all your eggs in one basket” reflects the wisdom of diversification. Spreading capital over a number of investments, lessens the possible losses that might arise if one (or even a few) investments perform poorly.
Asset classes are investment groups that behave similarly, exhibit similar characteristics and are subject to the same laws and regulations.
The most common asset classes are cash, domestic equity, international equity, domestic fixed interest, international fixed interest and property & infrastructure.
Asset classes broadly have different investment risk and return properties. Property, international shares and Australian shares are higher risk investments (i.e. volatility in returns) and cash, domestic fixed interest and international fixed interest are considered defensive (lower risk) asset classes.
Investing within an asset class can be undertaken ‘passively’ or ‘actively’.
What is Passive Investing?
Passive investing is an investment style that targets a benchmark index. Passive investing is often associated with a ‘set and forget’ investment strategy and is popular with ‘hands-off’ and non-active investors.
Passive investing provides broad diversification (depending on the index it tracks) at low investment management costs. A downside of this investment style is the inability to outperform a chosen investment benchmark.
What is Active Investing?
Active management is a style of investing that seeks to generate additional returns above a benchmark index or targets a different investment mandate altogether.
Active management, if engaged through an investment professional, can be expensive with no guarantee of performance. The key advantage of this investment approach is the ability to generate returns above a benchmark index or invest in a manner that targets an investment mandate completely removed from that of an index.
Investment Time Frame
Your investment time frame refers to the length of time you intend to maintain your investment portfolio. This plays a significant role in influencing your selection of investments.
For short to medium term investment time frames, there is insufficient time for long term market trends to override or ‘iron out’ short term volatility cycles which can significantly affect your returns. If you need to sell your investment at a specific time you could find yourself selling at the bottom of one of those cycles.
Real Life Example
Phoebe runs a business and is in her early 30’s. She has a personal investment account as well as a superannuation account. Phoebe plans to use her personal investments to purchase a home. Although her business income is variable, she anticipates doing this within 5 years. Conversely, Phoebe’s superannuation investments will (most likely) only become accessible to her when she is in her 60’s, in over 30 years’ time.
These two investment accounts require very different investment strategies:
- Phoebe’s personal investments require more capital security than her super investments as she will have to sell personal investments much sooner to fund her home purchase. This means Phoebe should have a greater weighting to fixed interest and cash investments in her personal account, compared to her super account.
- Phoebe’s super investments have a long investment time frame. They will pass through a number of cycles, benefitting from long term positive market trends. They can be invested in a higher proportion of growth (equities and property) assets than Phoebe’s personal investment account.
How To get Started
Technology has provided us with great tools to get started simply and cost effectively. All of us have bank accounts and each of the major banks provides online investment brokerage services. These are simple to establish and link seamlessly with your transaction account, making cash management straightforward.
The hardest part of investing is getting started. If you’re starting small then consider an investment that provides you with efficient diversification of investment capital, without triggering lots of brokerage costs.
Like running your business, it takes time to become accustomed to the ups and downs of investing. You may need to ride out a business cycle to grow in confidence and wealth. It is important to remain un-emotional about short term (less than three year) fluctuations in capital and avoid sitting on the sidelines waiting for the ‘perfect’ investment or time to start.
As your portfolio grows (and it will in time), you can become more targeted with your investment strategy, structure (trusts etc.) and philosophy. If you lack the time or expertise to do this or just want to more assertively manage your investments, then speak to a professional.