Investors have a mindset that is a long-term game. They're willing to take on some level of risk to achieve a return, but are more concerned about a smooth return for their portfolio over the long term.
Investors are not swayed by weekly, monthly or even yearly market fluctuations: they understand what they are invested in and know that markets behave in certain ways at certain times.
Did you know you’re already an investor? If you have a superannuation account, or any other retirement savings for that matter, you are already an investor.
Asset allocations within portfolios are listed as percentages. There are different types of assets and they can be growth assets or defensive assets.
Here are four key asset types you need to know about, and how they work.
Growth asset classes
Growth assets are there to do what they say: grow! To grow your wealth, ideally you want a decent chunk of your money invested into this asset class.
It’s important to understand that, usually, growth assets are best held for at least six years as the asset values may fluctuate.
I’ll let you in on the biggest secret to growing your assets: compound interest. A common growth asset many people know of is an investment property.
It produces an income for the owner (rent) but the value of the actual asset (the property) should also increase over time.
I reckon this is better than compound interest. Australian shares, for example, are companies listed on the Australian Securities Exchange (ASX). They are publicly traded companies and each day the share price is updated. Listed shares are generally considered fairly liquid.
Then there’s international shares that generally have the same liquidity as Australian shares based on the same concepts.
There can be some other inherent risks involved with international shares, such as currency (you can buy these with your currency or the currency of the country where they are listed) and other government and legislative risks to the local exchange.
Property and alternative assets
Property is straightforward. It can be residential, commercial or industrial.
But then there are alternative assets like infrastructure such as airports (these are usually non-government owned), electricity, water and gas.
Some fund managers might allocate these as growth assets and some may allocate them as defensive. There could be a case that the Sydney Harbour Tunnel has a stable flow of income and capital secure characteristics, so a portfolio manager may take the view that it’s defensive.
As a case in point, not all defensive assets are ‘safe’ and ‘reliable’. What would have happened to the income from toll roads and airports during the 2020 COVID-19 pandemic?
Defensive asset classes
Inflation is the cost of goods and services in an economy rising over time. The inflation rate is sitting around 3.8 per cent.
Inflation matters with investing, and so does the ‘real return’. Wages are not keeping up with inflation. Cash in a portfolio can be used as liquidity (always available to be drawn down on) or to smooth out portfolio returns.
It basically forms the first rung on your asset allocation risk/reward ladder.
It has a low return but is ‘at call’ (investment term for ‘gimmie now’), liquid and — in some instances for some of our own funds — government guaranteed (if the bank was to fail). It’s basic, but the returns are barely above inflation.
With fixed income the trade-off is with risk and return. The risk for you is liquidity. You can’t call up tomorrow and get your money out before the end of the term.
Did you know you can lend your own money to the government and they will pay you interest? There are various time frames for bonds (for example, 10 years).
At the end of the term, you would receive your capital back, plus interest. For example, during the global financial crisis (GFC), there were governments in Europe and other parts of the world that would have been risky to loan money to.
As with government bonds, with corporate bonds there is a time frame and an agreed percentage return.
Yes, these bonds are ‘defensive’ assets and should be ‘fairly capital secure’; however, the risks can become apparent when you look at the credit-worthiness of the borrower.
Will the company be around long enough to be able to pay you interest and pay your capital back?
To be great at investing you need to have the mindset of an investor.
In terms of society and history, the ‘traditional’ asset classes have been around for hundreds of years. It’s too early to make the call on where cryptocurrency fits into a portfolio.
It doesn’t make sense to me to use this as actual currency at this time. Investors are not a gamblers. Investors know the benefit of compounding interest and returns.
Edited extract from Sort Your Money Out & Get Invested by Glen James (Wiley, $32.95), available 1 October.