Australian finance experts usually agree on one thing: there are few vehicles better to invest in for the future than superannuation.
After all, you’re guaranteed contributions from your employer, your own contributions receive tax concessions and the government may even match some of your contributions. Plus, your withdrawals later in life are tax-free and super is the one asset that can’t be touched by a bankruptcy trustee if the worst should occur.
But what if you’ve reached the $25,000 annual cap that limits the amount of money on which you can receive a concessional tax rate by placing it in your super fund? Hitting the cap may sound luxurious, but it isn’t particularly unlikely for older workers who, freed from the expenses of children and mortgages, often dramatically ramp up their super contributions as they near retirement.
So, if you’re in this situation and want to save even more in any given year, or if you merely prefer to invest outside super so you can more easily access your nest egg, this means looking for suitable vehicles in which to grow your money. And while your investment options within super may be somewhat limited unless you own a self-managed super fund, outside super the global financial markets are your oyster!
That, of course, means there are many different kinds of assets to invest in, from commodities (gold is a common investment commodity) to bloodstock (you don’t even have to buy a whole racehorse). But the main asset classes used by personal investors are cash (in the form of a savings account or term deposit), fixed income (usually bonds or debentures), shares (in individual companies or via tracker, managed or exchange-traded funds) and property (as a piece of real estate or via property funds or trusts).
To choose the one or a combination of more than one that suits your needs, Tim Howard, a technical consultant at BT Financial Group (BTFG) suggests considering three key factors: your risk appetite, your desired return and your timeline for investment.
Your risk appetite
Everyone has one of these. Howard describes it as your personal ‘sleep at night test’ – the level of risk (in life, as much as in finance) you can bear and still sleep comfortably at night.
Knowing your personal risk appetite will help you decide what level of risk you can accept in order to generate returns on your investment. Howard says a common way of getting a feel for your financial risk appetite is to ask yourself whether you can tolerate a loss in the value of your investment.
Those, for example, who can’t bear a loss in value may opt for a ‘safer’ investment such as a bond issued by a large, well-known Australian company, while those who can bear some loss in value may go for shares in the same company, and those who’re willing to risk the loss of the whole investment may, say, opt for shares in a similar company that operates in an emerging market.
“People tend to gravitate to the investment they understand the most,” Howard says, noting that that’s why owning a rental property is a popular investment with Australians.
Cash, another easily understood asset, is usually considered the lowest-risk asset class – unless you’re investing in or trading foreign currencies – and high-quality fixed income products are also considered relatively low risk. Shares are one type of asset that are considered higher risk.
It’s worth remembering, however, that the way in which you invest can impact the potential risk. For example, the risk inherent in buying shares can be mitigated by investing through a fund so you’re not exposed to the fortunes of a single company. Property-related risks can be mitigated in a similar way by investing in a trust that holds a portfolio of property (usually commercial ventures such as shopping malls and industrial estates) assets, avoiding the risk of a single suburb tanking in value.
Your desired return
Your risk appetite will be impacted by the return you hope, or need, to generate from your investment. That’s because the old saying ‘risk equals reward’ holds as true in finance as it often does in life – the riskier the investment, usually the greater the potential return. For example, term deposits, which are generally a low-risk asset class, tend pay a low interest rate, while so-called ‘junk bonds’ (the debt issued by companies with poor credit ratings), which pose considerably more danger to your nest egg, sometimes provide a higher return.
“It comes down to what level of volatility, or change in your investments value, you’re comfortable with and the level of security you need over your capital, and on the flip side, how much income you need the investment to generate,” Howard explains.
The rate of return an investment provides is particularly key to investors who are near or in retirement, because they need their assets to at least partially replace the income they used to generate from paid employment.
A common way to balance this need for a specific return with a risk level that passes the sleep-at-night test is to diversify your investments. As BT’s Howard explains, diversification, which is one of the bywords of investing, effectively means not having all your eggs in one basket. Instead, your capital is spread over a range of asset classes with varying degrees of risk and return.
“A good thing you can do is diversify your investment portfolio,” he says. “That way, you’re going to benefit from good performers and you’re also going to reduce the impact of the bad performers.”
Your investment timeline
Diversification also helps investors to manage their investment timeline – that is, the length of time in which they need to generate a return, balanced by their need for access to their capital.
Understanding your personal investment timeline is particularly important to people near or in retirement because increasing longevity means their assets will have to support a retirement that’s likely to be significantly longer than those of previous generations.
Howard explained that an investment strategy called lifecycle investing was used in the past to guide investors into higher exposure to growth assets earlier in life while they had a long investment timeframe, and then to shift gradually to more conservative assets as they neared retirement. But with increasingly lengthy retirements to fund, he says most investors now need their capital to keep growing during the retirement period to create an income over many more years than would’ve been required in the past.
“As you approach retirement you may want to move to more conservative assets to allow for greater security of capital, but you also need to consider your retirement could last 35 to 40 years,” Howard says. “You’re going to be relying on your savings for an income over a period that may be as long as the time you spent in the workforce, so you do need to think about the level of income you need during your retirement years when deciding where to allocate your investments.”
Howard also suggests that investors think about the timeframe in which they may need access to their capital when choosing where to invest, because most assets have some cost of acquisition that will take time to recoup from returns – for example, stamp duty and conveyancing costs on a property purchase – and some assets need to be held for a considerable period to show any return at all.
Howard uses the example of residential property, which involves relatively heavy acquisition costs, usually needs to be held for some time before achieving capital growth and can be difficult to dispose of quickly. Investors who don’t want a big initial outlay and need quicker access to their capital could consider a property trust, for example, he says.
“That way you still get exposure to the property market, but you’ve got it through a traded instrument that you can generally buy and sell out of more quickly,” Howard explains.
Making choices such as whether to invest in a property or a property trust is a very personal decision, he adds.
“There’s a multitude of ways that you can achieve the outcome you’re targeting, and it really comes to your own unique circumstances and working out what’s right for you from an investment and income point of view,” Howard concludes.
He encourages everyone saving for retirement to read the free information available online on their potential asset choices, then consider consulting a financial adviser if they still have questions.
If you invested outside super, which asset class would be your top pick? What kind of investment passes the ‘sleep at night’ test for you?
BT Financial Group is a subsidiary of Westpac Banking Corporation ABN 33 007 457 141, AFSL and Australian Credit Licence 233714. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. The information provided is factual only and does not constitute financial product advice. Before acting on it, you should seek independent financial and tax advice about its appropriateness to your objectives, financial situation and needs. Any tax considerations outlined in this article are general statements, based on an interpretation of the current tax law, and do not constitute tax advice. Superannuation is a long-term investment. The government has placed restrictions on when you can access your preserved benefits. The Government has set caps on the amount of money you can add to superannuation each year on a concessionally taxed basis. In addition, the government has set a non-concessional contributions cap. For more detail, speak with a financial adviser or visit the ATO website.