How on earth do you choose an investment from the thousands of products that are available? Skimming through the weekend paper, the media and "The Industry" bombard us with impressive-sounding numbers and pretty pictures. Where do you start?
A little background knowledge can help clear the fog. Despite the thousands of products on offer they all consist of just four basic investments, albeit in different quantities. They are cash, bonds, property and shares.
1. Cash
Safe, dependable cash. You know where you are with cash. You get paid interest too — but take off tax and then adjust for inflation and you're real returns are usually relatively minimal.
2. Bonds
Bonds are essentially loans that can be bought and sold. The most common are government loans, called Government Bonds in Australia, Treasuries in the UK, and Gilts in the UK.
Large companies raise money by selling bonds, usually to institutional investors. The capital value of these bonds moves up and down in relation to company risk and interest rates.
Bonds aren't nearly as popular or widespread here in Australia as they are in the US. In fact, accord to the September 2010 Reserve Bank of Australia Bulletin, Australian households' direct participation in the bond market is less than 1% of all Australian bonds on issue.
We therefore won't go into bonds in any depth here, except to say over the long term, bonds generally return slightly more than cash, but not by much.
3. Property
Many people believe that property is the best investment of all thanks to rising house prices over the last few decades. The value of your house may have leapt over the years, but don't forget all that money you have paid out to fund the mortgage!
Just how well property has done is actually quite hard to calculate however (you need to include bills for repairs and maintenance for example). In addition, it can be awkward to buy and sell — you can't sell little bits here and there when you need the money.
Most people already have a large chunk of their assets in property, by virtue of owning their own home.
Some people also own investment properties. Good luck to them, we say. Just about every property investor has seen the value of their asset rise and rise over the past 15 odd years. Does that mean property makes for a good investment in the next 15 years?
We're not so sure. Rental yields are generally very modest. In fact, in July 2010, The Economist noted Australian property as being 61.1% overvalued on long run average of price-to-rents ratios. It also noted "…Australian property is the most overvalued of any of the 20 countries we track."
4. Shares
Shares, or equities, mean investing in a company like BHP Billiton (ASX: BHP), Australia and New Zealand Banking Group (ASX: ANZ) or Wesfarmers (ASX: WES). You can buy shares in individual companies yourself, or you can buy a fund that invests in a broad range of companies on your behalf.
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