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Property Investment

The Money Mummy Guide to Investing is back and this week we are going to look at the risk and return characteristics of property investments and how these could fit into your overall investment strategy.

Now as Australian’s we are renown for being in love with property.  It is easy to see why, residential property has been an amazing performer, such that we now have some of the most expensive residential property in the world.  I will have to admit, I have a bias against Australian residential property as an investment, right now.  Simply because on most measures it is simply unaffordable.  How many people do you know who are struggling to buy a property?  So despite low interest rates, in my view there is little room for property prices to keep on climbing.   (I will also admit that I said this five years ago when we brought our family home, at the height of the global financial crisis (GFC) and was proven completely wrong as property prices continued to climb!)

Now I am no expert in property investment (given my bias I have never brought an investment property) but here are some of the main advantages of investing in property:

  1. It is an investment that you can see and touch, so in that sense it is easier to understand than say an investment in shares
  2. Property returns, over time are seen as less volatile than shares
  3. You can earn rental income as well as benefit from capital growth, if the price of your property increases over time
  4. In Australia there can be tax benefits in purchasing an investment property, if the property is negatively geared (ie. the cost of the interest on the loan is larger than the rental income received)

The main negatives of investing in property include:

  1. The rental income, particularly nowadays, quite often does not cover your mortgage repayments or other expenses so you might have to use other income to cover these costs.
  2. Your returns from your property investment may be vulnerable to changes in interest rates, depending on the structure of your loan.
  3. If you urgently need to raise cash, selling the property might take a long period of time.
  4. You will have to cover all the costs if the property is left untenanted for a long period of time or if the tenants do not pay the rent.  You are also at risk that the tenants may not look after the property as you expect.
  5. Entry and exit costs are high, for example stamp duty and real estate agents costs.
  6. Residential property is a chunky investment.  If this is your main investment plus your family home you might lack diversification in your investment portfolio.  This means you are very exposed to any decline in residential property prices.  This was a hard lesson learnt by many American’s during the GFC (Global Financial Crisis).

It is often forgotten that property investment does not just have to be about buying a house or a flat.  There are many different types property investment that can be accessed through a managed fund or investment on the stock market (I will talk about these two forms of investment in a later post).  For example, within the property segment you can invest in retail property (ie. shopping centres), office buildings or industrial buildings.  Some investments offer you pure exposure to these segments or a mix of the three.  Each segment is driven by the same overall characteristics as residential property, it is all about collecting rent and capital gain in the overall price of the property.  However, each segment has slightly different drivers, for example shopping centres (retail) is more related to how much consumers are shopping, where as office buildings are more related to the growth in business spending.

If you are considering an investment in property right now, make sure you get some good advice.  Beware, there are many property spruikers out there who encourage you to borrow heavily and build large property portfolios quickly, this will leave you dangerously exposed to any fall in property prices.  Prices are high, so be careful and think hard before you commit my fellow investors!

If you liked this post check out the rest of the series by clicking on the links below:

Investing: How Do I Get Started?

What Is My Risk Tolerance?

Risk and Return

What Are My Investment Choices?

Fixed Interest Investments

 

Happy Investing!

 

Money Mummy

 

* Please note this post is for your general information only and does not constitute financial advice

04/07/2013 0 comment
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Fixed Interest Investment

This week we are going to look at the risk and return characteristics of fixed interest investments and how these could fit into your overall investment strategy.  When you make an investment in a fixed interest product you are essentially agreeing to lend an institution (say a bank in the case of a term deposit), or a government (in the case of a government bond) or a company, money.  In return they agree to give you regular interest payments and at the end of the period they will give you your initial investment (capital) back.

Common examples of fixed interest investments include:

  • government and semi government bonds,
  • corporate bonds,
  • term deposits,
  • secured and unsecured notes
  • hybrid investments.

Generally speaking, fixed interest investments are considered to be more risky than holding your money in cash but overall are considered quite low on the risk spectrum.  But it should be noted, just because an investment is in the fixed interest area this does not necessarily mean that it is low risk and that you will get all the capital you invested back or that you are guaranteed to receive interest payments. As always, you need to understand the true nature of the investment and the risks associated with the investment.

So here are some things to look out for when making a fixed interest investment:

(1)    How often are the interest payments made?  Some investments pay monthly, some quarterly and some annually.  Make sure the timing of interest payments meets your investment needs.

(2)    Are the interest payments fixed or variable?  Just because the sector is called fixed interest, it is not necessarily true that your interest payments are fixed, it depends on the type of investment.  Some investments in this sector make variable interest payments.  This means that the amount of interest you receive rises and falls with movements in the level of official interest rates set by the Reserve Bank of Australia.  So if you had made one of these investments a couple of years ago, your interest received would have reduced in line with official interest rates falling.  If the interest rate is fixed, then you will receive the same amount of interest over the life of the investment, regardless of what happens to official interest rates.

(3)    Is the investment for a fixed term or at call?  At call investments mean that you can access your money at any time (although some products may require a day or two’s notice).  If your investment is for a fixed term, it means you are invested for a specific length of time.

(4)    Ultimately who are you lending your money to?  Knowing this will help you judge how likely it is that you will get all your interest payments and your capital back.  So in the case of a term deposit, as you are lending your money to a bank.  This is considered one of the lowest risk forms of fixed interest investment.  In the case of a government bond, you are lending your money to the Government.  Nowadays, this is more tricky to judge how safe your money is, as it depends on which government :-).  If you are lending your money to a company, the amount of risk you are taking is very dependent on the type of company, their own individual financial situation and the industry they are in.  It is very important to understand who you are lending your money to as this very much determines the overall level of risk you are taking in your investment.

(5)    Watch out for the term “secured” in the name of your investment, it doesn’t necessarily mean that your money is safe it simply means that the issuer has provided some form of security to the trustee of the note issue.

So if you want a relatively safe investment, giving you regular interest payments, the fixed interest sector might be for you.  But like with all investments you need to understand all the terms and conditions to make sure that the investment meets all of your needs.  As despite the name, fixed interest investments can be very different in terms of risk and return.

Next week we will look at the characteristics of investing in an old Aussie favourite – property!

If you liked this post check out the rest of the series by clicking on the links below:

Investing: How Do I Get Started?

What Is My Risk Tolerance?

Risk and Return

What Are My Investment Choices?

Fixed Interest Investments

Investing In Property

Happy investing!

 

Money Mummy

* Please note this is for your general information only and does not constitute financial advice

23/05/2013 0 comment
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So now you have an idea of your risk profile (tolerance) and you understand the relationship between risk and return, it’s time to look at characteristics of the broad asset classes or types of investment.  It is important to understand the different investment types as each category has different levels of expected risk and return.  Understanding what to expect from the different asset types will help you decide which categories of investments best suit your investment goals and your timeframe.

Generally speaking, there are considered five broad investment types or asset classes:

  1. Cash – investments like savings accounts, high interest accounts, bank bills
  2. Fixed Interest – includes government bonds and bond like securities issued by companies called hybrids
  3. Property – includes residential, retail, industrial and office properties.
  4. Australian Shares – are shares listed on the Australian Stock Exchange which cover many different sectors such as mining, healthcare, banking and retail.
  5. International Shares – are shares listed on exchanges outside of Australia including places like the United States, Europe or Asia.

I have listed the asset classes in order of risk.  Generally speaking, cash is considered the least risky investment type and international shares are considered the most risky.

Given the Reserve Bank of Australia (RBA) cut rates again this week it is appropriate we kick off our look at the different investment types with a look at what is considered the safest but lowest return option, cash.

Cash generally refers to investments in high interest bank accounts, term deposits, bank bills and other securities which have a relatively short investment time frame.  An investment in cash provides a stable, predictable income, in the form of regular interest payments.  This category is all about income, with very little risk.

You might have heard the saying “cash is king”?  This saying is usually used when the share market is very volatile.  During these periods, such as the global financial crisis (GFC), investors move into cash for its safety and security.  The problem with cash right now is that interest rates in Australia are at their lowest level since 1960, this means the returns on cash are at very low levels.  However, if safety and security are your top priority or your investment time frame is short, then you can’t go past cash as an investment option.

Inflation is the other issue you need to be wary of when investing in cash, especially when interest rates are low.  Anyone who goes shopping knows that, generally speaking, the price of things goes up every year.  This is called inflation.  It means that a dollar today will buy less goods and services in one years’ time as prices have increased.  At the moment inflation is around 2.5%.  So if you invest in an online account with an interest rate of 3.5%, then your post inflation return is only 1% (the difference between the interest rate earned and the inflation rate).  If inflation is high and interest rates low, then it is possible to make a negative return after accounting for inflation.  For example if inflation is 5%, but the interest rate earned on your account is only 2%, then you will earn a negative return of 3% after accounting for inflation.  This is because the increase in the general level of prices, inflation, is greater than the increase in value of your investment through the interest earned.  This is why it pays to shop around for the best cash rate possible and look out for any bonus interest deals.  One of the best ways to do this is to use a comparison site.  Two of my favourites are:

Canstar

Mozo

They both can give you comparisons on rates for online savings accounts and term deposits, including any bonus rates.  Don’t be afraid to take the best bonus rate then move your money after the bonus period has finished.  But remember, like with all investments read the full terms first before making any investment.

Next week we will look at the characteristics of fixed interest investments.

If you liked this post check out the rest of the series by clicking on the links below:

Investing: How Do I Get Started?

What Is My Risk Tolerance?

Risk and Return

Fixed Interest Investments

Property Investments

Happy investing!

 

Money Mummy

* Please note this is for your general information only and does not constitute financial advice.

09/05/2013 2 comments
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