PART I:
What you need to know
Part I outlines the knowledge you need to have to make sound investment decisions. It begins by looking at investing today, including a discussion of the global financial crisis. Chapter 2 then introduces fundamental investment terms such as simple and compound interest and how, by saving a small amount regularly, you can accumulate a large sum over a long period. More complex investment terms such as negative gearing, derivatives, diversification and dividend imputation are also explained. The factors you need to consider when structuring an investment portfolio are examined, as are the records you need to maintain to track your investments for tax purposes and to measure the return from your investment portfolio.
The important issue of obtaining sound financial advice is considered with a review of the questions you need answered to ensure you get appropriate guidance. The potential disadvantages of paying financial advisers via commission are considered and the findings of a government inquiry on this issue are summarised. Most investors will want to know how to make best use of the internet in trading and researching investments. This is outlined in chapter 6. The final chapter in part I summarises the main sections of the Australian tax system that apply to investors and provides you with an understanding of what you need to know to legally minimise your income tax liability.
Chapter 1: Investing today
Why learn about investing?
In the 1960s and 1970s only about 10 per cent of Australians owned shares directly. In the 1980s and 1990s this changed dramatically following major privatisations, including Qantas, Telstra, the Commonwealth Bank and AMP. Currently around 50 per cent of Australians own shares directly or through managed funds. This puts Australia in equal first place with the US in share ownership per head of population. Unfortunately, most of the privatisations took place in a bull market. As a result, many investors did not really understand the risks they were taking by investing in shares. When world sharemarkets turned down in 2000, these new sharemarket investors were taken by surprise by the severity and suddenness of the decline. Since then worse has happened with the global financial crisis (GFC), when share prices declined by much more. These events highlight that there are numerous traps for the unwary in financial markets.
As there are now more investment products from which to choose, investing wisely has become more important than ever. The government has made it clear that everyone should be more financially responsible for their retirement. So if you do not save and invest successfully during your working life you may suffer a major decline in your standard of living when you retire.
Remember that the average life expectancy in Australia is around 80 years. So if you retire when you are 60 the savings you accumulated during the approximately 40 years of your working life will have to last you around 20 years.
Interest rates and the Australian dollar are now determined more by market forces than government decree. Again this can provide profitable opportunities for anyone who understands the implications of this. Or it can simply be another trap for the unwary investor.
It is essential to educate yourself about investing, as there are many people who make a living by selling investment products. There are over 16 000 licensed investment advisers in Australia and not all of them are competent. If you decide to seek guidance from an investment adviser, it is still a good idea for you to have some basic understanding of how financial markets work so you do not put your hard-earned money into the hands of a less-than-professional financial adviser.
Most daily papers contain numerous advertisements extolling the virtues of one investment product or another. How can you tell whether a particular investment product is right for you? The only sure way is to become familiar with the language used in the financial industry.
The long-term benefits of becoming more financially wise are enormous ā as are the costs of allowing yourself to remain financially illiterate. These days we are all bombarded by people trying to sell financial products such as life insurance, managed funds, superannuation, home loans, margin lending schemes, exchange-traded funds, contracts for difference, hedge funds, warrants and personal loans. Unless you know how these products work you could end up paying too much, losing your money or buying something you donāt really need.
The chance of losing money through unwise investments seems to have increased. In recent years in Australia there have been several spectacular corporate crashes, such as Timbercorp, Opes Prime and Storm Financial. These resulted in investors losing thousands and sometimes tens of thousands of dollars. In addition, the Australian Securities & Investments Commission estimates that more than 100 000 Australians have lost money in fraudulent or illegal investment schemes in the last 15 years, and many of these were intelligent people. In the US, Bernie Madoff ālostā US$50 billion of investorsā money.
Does this mean you should play it safe by keeping your money in the bank or under your bed? Generally the answer is no ā but there certainly is a need to understand the types of risks you are taking when you invest.
With this changed investment environment has come a need for investors to know more than they have ever known before.
Financial information
These days everyone is an investor. Investing is not difficult, but to be a competent investor you need to understand what you are doing. There are many traps for the unwary. Knowing how to use financial information is crucial for making sound investment decisions. Establishing what information you need and where to obtain it is another essential part of this book. Clearly, not all areas regarding the provision and use of financial information can be covered at the same time. The foundations for effectively using financial information are twofold. Part I of the book deals with what you need to know. Part II looks at investment options.
Financial information is published constantly in numerous forms that are often not comprehensible to the layperson. Many investors, financial advisers and stockbroker analysts are expert in using financial information and already know where to obtain it. This book is written for non-experts who are interested in deriving a working knowledge of financial information and its sources.
Ground rules for successful investing
Before examining different financial investments in detail there are some ground rules for successful investing that have stood the test of time. With time, patience and effort you can be a successful investor in all of the arenas that are open to you. This will not come overnight and you will have to confront the risk of losing some of your money. But, if you persevere, you will be a successful investor. The road is not always easy, but nothing worthwhile is.
My ground rules for successful investing have not changed from previous editions of this book, and they are:
1 Be your own investment manager. No āadviserā or stockbroker should do it for you. Only you know what your real needs and temperament are and only you are motivated by your own best interests ā not by the chance of earning a sales commission. It is also more fun to do it yourself.
2 Confront risk and then reduce it through spreading your investments. This is referred to as ādiversificationā, āasset allocationā or āportfolio balanceā.
3 Take a ācontrarianā stance in investment markets. That is, look for opportunities to watch what the āherdā is doing and then do the opposite.
4 Do not be put off by investment jargon. After reading this book you will be on top of it.
5 Itās always a good time to start. Do not wait for markets, such as the sharemarket or the property market, to get better. If the sharemarket is filled with gloom, it may be the time to buy bargains.
6 Make good-quality shares the core of your investment strategy. Then you can rest easy when you invest in more speculative areas.
7 Always consider the tax implications of making investments, but never let tax minimisation be your main objective. The fundamental rule is to think in terms of after-tax returns.
8 Keep up to date through reading the financial pages of a major daily newspaper. Later you can extend this to include more specialised publications such as AFR Smart Investor, BRW magazine and others.
9 Discussing investment is stimulating. Condition your mind to talking to others about it, especially those more knowledgeable than you are.
10 Do not be greedy. Discipline yourself to cut your losses with a bad investment and to cash-in when you have made a reasonable profit.
11 Be patient. You probably will not become a millionaire overnight through investing, but you can expect to make money over time.
12 Never invest in anything you do not understand. If a particular investment sounds too good to be true it probably is.
13 Pay yourself first. Many people put off learning about investing because they claim they do not have any money to invest. The solution is to set aside a portion of your income each month ā say 5 or 10 per cent ā to build up your initial investing capital. By doing this you will force yourself to become an investor and the longer term benefits will be enormous.
If you can master these 13 ground rules you will be a successful investor. You will rival so-called professionals and you will sleep easily at night knowing that money is the least of your worries.
The aim of this book is to inform you so that you can make better investment decisions. Alternatively, if you wish to entrust your money to a professional investment adviser, you will be better able to assess how well he or she is doing with your money. This book focuses on the relevance, use and acquisition of information relating to investment. It explicitly recognises that many investors are new and unfamiliar with the sources of financial information that are available, and their use.
This book gives you an introduction to the main types of investments available to individual investors in Australia. Before focusing on specific investment choices there is some discussion of basic investment terms as well as the very important matter of risk and return. This will show that risk and return go hand in hand and that the best way to hedge against risk is to spread your investments across different areas. The tax implications of various investments are discussed, as is the importance of keeping track of your investments.
Reading this book will empower you with financial knowle...
