If you want to build a substantial portfolio, you need to seek the best return that fits your risk profile. Picking the right assets is critical: for most people, it comes down to choosing between cash, property and shares.
Each investment choice has its advantages and disadvantages, and I have long stressed the advantage of diversification. However, it's important when making any investment decisions to understand the differences.
Let's start with cash. Certainly, cash in the bank may give you the feeling that you have a risk-free investment, but cash is the riskiest investment in the long-term. There is no chance of capital gain, which means your money is being eroded every year by inflation, and there are no tax concessions on the income.
Many investors like the perceived security of bricks and mortar, which is why property is such a popular investment in Australia, but you need a large chunk of money to get started, and you may still need to borrow as much as half a million dollars. And property can lose its gloss for retirees as their ageing properties require increasing maintenance and become harder to rent. But the worst aspect is the lack of liquidity - if you need money in a hurry you have to sell the entire property because you can't cash in the back bedroom. Selling can take months and often triggers a large capital gains tax bill, which can take a big chunk of your capital.
This gets us back to shares, which have long been my favourite. However, many people are terrified of shares. I hear things like "playing the share market is risky", "I bought some shares once and lost all my money", or "I really have no idea what company I should invest in".
Well, it doesn't have to be like that. Today I will tell you about a little-known investment that has a proven track record of better than 8 per cent a year over the past 30 years, which cannot go broke, has unique advantages of liquidity and tax-advantaged income, and takes no skill whatsoever on the part of the investor. I am talking about index funds, which simply rise and fall in line with the index.
Index funds are designed to cover shares from all of the companies listed on a particular index.One of the most common types is the exchange-traded fund (ETF).
Because they are designed to track the market, index funds will follow the market up and down. So, if you are watching the nightly news, and are told that the All Ordinaries is down 1 per cent on the day, your investment in that index fund will be down by the same amount.
It is also possible to buy international index funds, which cover a wide range of overseas markets, but I believe for international investments it is better to go through a top fund manager. Remember, our share market is less than 2 per cent of world markets, which means there are a multitude of companies, and indices, to choose from when you are investing internationally.
One of the best things about investing through index funds is that the data is readily available, and you do not have to make any specific share decisions. Just choose an index fund that matches your goals and you automatically become a part-owner of every share that forms part of the index.
If you want to see how well the All Ordinaries Accumulation (which includes income and growth) has performed, just go to my website www.noelwhittaker.com.au. Under Calculators, click Stock Market Calculator. This enables you to enter your choice of starting and finishing dates between January 1980 and September 2017 and enter a theoretical sum to invest. The calculator will tell you how much you would have had if your portfolio matched that timeframe.
It's always interesting to enter the date you bought a property and the price paid, and compare what you would have had if you had made that investment in an index fund instead.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: noel@noelwhittaker.com.au
