The love affair between Australian individuals and their bricks and mortar properties is well known and will continue to be part of our culture in the future.

However in some pockets of the country, the reality of purchasing property is starting to become blurred and in some cases impossible. It can be difficult to get a real return above RBA interest rates for some investment-grade detached housing and professional commentators have suggested pockets of units are now in price decline.

So where does an individual invest their cash and / or super monies so that investment objectives are met in both short term and long term?

Know your asset allocations 

There are three asset allocation areas I will discuss in this article:

1. Cash and Term Deposits
2. Fixed Interest
3. Equities

Cash and Term Deposits

It is still common for people to hold cash or term deposits as long-term assets for their investment portfolio. This strategy can be effective for short periods of time and to diversify a portfolio, however cash and term deposits are probably not the best asset allocation option for long-term investment.

On the positive side, liquidity is easy and the capital is guaranteed to a certain amount, and if you hold a term deposit to maturity you will get your money back.

There will always been some exposure to cash and term deposits in a diversified investment portfolio. Current returns are anywhere from 0% to 3% for 12 month term deposits.

The interest earned on these investments is taxed at the investor’s marginal rate of tax.　

Fixed Interest

This asset refers to corporate and government bonds and other credit grade products. An investor can either hold these bonds directly, or through a unit trust style managed fund.

Fixed interest or bonds provide a defensive component to a diversified portfolio. Interest rates are usually higher than term deposits but the risk is also greater - that the money invested does get returned.

The value of a bond may also fluctuate depending on the interest rate environment and the creditworthiness of the issuer over the life of the issued bond.

Commentary around the movement of interest rates here in Australia and overseas, adds a layer of nervousness to owning fixed interest funds, but whether interest rates rise, go down or sideways, professional managers adjust the duration of their holdings to compensate.

As interest rates go up, or are perceived to be going up, new bond issues become more attractive compared to other asset classes, namely property and certain equities. That is why you hear in the investment world that bonds are negatively correlated to the equity market.

Depending on individual risks and objectives, investing a portion of your portfolio in the fixed interest environment is prudent. Investing into diversified fixed interest funds can also achieve further diversification and risk reduction inside your portfolio.

Fixed interest funds provide two sources of return: interest – which is taxable at the investor’s marginal rate of tax; and a capital gain or loss – depending on circumstances which is also taxable in the hands of the investor.

Equities

Can be categorised further into domestic equities and international equities, and also large cap and small cap equities.

Within the above, individual industries can be invested into as well.

Equities can be purchased and held directly, or an investor can purchase units in a managed fund (either active or passive) or hold ETFs over an index or market they believe is worth investing in.

Owning equities is risky, as the price you paid for a share may not be the same tomorrow, next week or in a year’s time. The ability to have a long term time horizon for investing in equities is important for this reason. Having an investment horizon of a few months and requiring the same capital return does not lend itself to equity investment. Other asset classes are more suitable.

Equities provide an income stream in the form of dividends, which if the company is an Australian company, the dividend may also have a franking credit attached which is useful as a tax offset. Equity prices can go up or down, so a capital gain or loss may occur resulting in additional tax when realised.

Purchasing a share in a company (which is a business) gives the investor the best opportunity to increase wealth, as you expect the company will grow its earnings over time, resulting in the share price going up. This may take some time or be an overnight sensation. There are no crystal balls in the investment world – just opinion.

Investing both in domestic companies and international companies is prudent, as companies are global and each country or region has their own issues at any one time. Some industries are not even found in certain countries so having international exposure becomes a must.

Summary

We are in a challenging investment environment. Broadly speaking, asset classes look unappealing. Low interest rates reduce the appeal of bonds and elsewhere, high property prices and a seemingly expensive sharemarket make it difficult to find cheap assets.

Investing is a marathon and not a sprint. Fads and fashion dominate in the shorter term with fundamentals and quality coming to the fore over the longer term.

It is important to understand your own individual risk profile and investment time horizon so your asset allocation matches these objectives. It can be expensive to reweight or sell outright assets due to circumstances changing. Being nervous about certain investments may lead to selling at the wrong time which is expensive as well.

Having a diversified portfolio spread across different asset classes assists with long-term returns as not all assets perform equally all of the time. Having property is an important part of the investment framework but there are also many asset classes that can give investors a good return on investment without the large capital outlay and transaction costs, and also have the liquidity and flexibility in case individual circumstances change.

More information

For more information, please contact Ian Walker from Lantern Advisory via ianw[@]lanternadvisory.com.au or phone 07 3002 2690.

Disclaimer
The information contained in this article is of a general nature and does not take into account personal circumstances. Before making any decisions based on the factual information contained in this document please consult with your financial adviser.