9 investing questions everyone should ask (and answer)
The thought of investing can be daunting to some. It often seems like there’s too much information out there and no simple way to decipher it. We’ve compiled a series of questions everyone who is investing or thinking of investing should ask themselves and be able to answer.
1. What age will you/did you start investing?
The benefits of staring investing early are staggering. The earlier you start, the quicker your savings will grow due to compounding.
Say, you’re 35 and you’re investing $50 a month over 30 years. Assuming your investments grow at 5% annually, you will have amassed savings of $44,541 by the time you are 65.
Now consider that you started investing at 21, not 35. Your investment pot would, based on the same logic as above, be worth $101,744 by age 65. By starting at age 21 instead of 35 your retirement savings ends up being over 2.2 times larger!
The above calculations haven’t been adjusted for inflation.
Please remember past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
2. Have you spread your money around?
Be careful not to put your eggs in one basket. Diversifying your investments means buying different types of investments, potentially across different countries and/or asset classes. It can help to balance portfolio returns when a certain investment underperforms.
Diversification doesn’t guarantee you won’t lose money but it should smooth the highs and lows. It also helps you retain access to the money you need: In times of stress the ease in which you can buy and sell an asset is critical. This varies between assets, and is known as liquidity. For instance, property can be more illiquid than equities.
3. How much risk are you willing to take?
There’s a crucial trade-off you face as an investor - take more risk and there’s the potential for more reward, but this can come with a bigger chance of losses. The risk spectrum, from low to high, generally moves from cash/savings; government bonds, corporate bonds, high-yield corporate bonds, developed market shares, to emerging market shares and alternatives.
4. What can you afford to lose?
Part of the process of taking on risk is working out how much you are comfortable with losing. For instance, if you invested $100 how much would it impact your plans if your investment fell 20%? Someone approaching retirement, for example, may be uncomfortable with this level of risk, whereas someone who is earlier in their career may be willing to take this risk. What you’re willing to lose should influence the types of investments you make. Note, your answer to this may help you answer to question 3.
5. What is your time horizon?
Think about the time horizon for your investments. Are you saving for something short-term, such as a holiday, or a longer-term goal, such as your retirement? Having a clear understanding of how quickly you want to access your money will help you determine what type of investment might be right for you. For instance, you might not want your money tied up in an investment which can fluctuate dramatically and is difficult to access if you need your money in the short-term. For a long-term goal, you may be able to afford to take on more risk, because you have more time to allow for any potential losses to be recouped and hopefully built into gains.
6. Will you reinvest your income?
Your investments typically generate income: shares pay dividends, bonds pay interest (coupons), savings accounts pay interest. You can elect how you want to receive this income. – either cash or use the income to increase your investment, i.e. reinvesting your income.
If you elect to reinvest your income, this can trigger the effect of compounding. Compounding, put simply, is interest on interest and it can help an investment grow at a faster rate. By reinvesting income, you give your investment the potential to earn even more income in the future, and the process goes on.
By way of example, let’s say you invested AU$1,000, 10 years ago. During your investment you decided not to reinvest the income you received fro this investment, pocketing it each time it was paid. Ten years later, your AU$1,000 would be worth AU$1,501 (equivalent to an average annual return of 4.1%).
However, if you had opted to reinvest the dividends, buying more shares, your current shareholding would be worth AU$2,310 (an average annual return of 8.7%)
The same thing can apply to funds. Most funds offer you the chance to reinvest your income which may see your investment grow faster with the benefits of compounding.
Remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
7. Have you included inflation in your investing plan?
Inflation is effectively the rising cost of living and it can erode the value of your money and investments.
For example, $100 ten years ago would effectively be worth just $76.50 in today’s money. That is because of inflation, which has averaged 2.3% in Australia since 2008.
When you invest, the aim is to grow your money at a rate that will help you meet your goals and comfortably exceed inflation, otherwise you effectively lose money.
8. How much are you paying in charges and fees?
If you’re investing in shares directly, the buying and selling cost should be obvious – the trading fee. If you are investing in managed funds or ETFs it’s common to find you may also have to pay an annual fee or a percentage fee of your assets. Even seemingly small charges of 1% a year can have a significant effect on your investment returns over the very long term.
With funds, the fund management firm will apply an annual management fee and there may be additional fund operating costs. tThe better measure is to look for the total management costs which includes all fees and costs of the fund.
As with shares, you may need to pay a broker (also known as an oline broker or investing platform) an ongoing fee. These are typically around 0.2% to 0.5% but can also be flat fee amounts. The benefit of this is you can hold a mix of funds from different fund management companies.
9. Do you have a plan for putting away more savings?
The easiest way to allocate more of your savings to investing is to make a commitment that for any additional earnings, such as pay rises or bonuses, you will direct a portion of the extra money to your investment account. If you never have it, you’ll never miss it.
In conclusion, whether you are a seasoned investor or starting out on your journey, it’s important to ensure you ask yourself some important questions: how long are you investing for; how much risk are you willing to take on, is your money diversified; what will you do with the income you generate; are you considering inflation and what fees are you paying? We hope that this guide has provided you with some helpful points for you to consider.
For further information please speak to your financial adviser who can help you work through these considerations and much more.
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