The ABC of Investing
Smart investing starts with understanding the basics. Becoming familiar with the fundamental concepts will help you make smart and effective investment decisions.
What are Mutual Funds?
Mutual funds are investment tools that provide a convenient way to participate in equity and bond markets and other asset investment opportunities across the world.
The funds pool money from a group of investors seeking capital growth in similarly defined target investments.
Investing in a mutual fund lets you access a larger pool of assets than you could as an individual. The funds enable you to put your money into a wide variety of securities including stocks, bonds, and money market instruments.
Mutual funds are very cost effective investments because the expenses are shared by other investors and across a large pool of assets. You can invest in a mutual fund with just a few thousand dollars.
Each fund is managed by professional fund managers so you get the same expertise working for you as large corporations have working for them.
Understanding Asset Classes
Most unit trusts (another word for mutual funds) invest in one or more of the three basic asset classes described below:
Understanding Risk and Return
The relationship between the potential risks and returns of investments is commonly called 'the risk-return profile'.
Generally, low-risk investments such as cash offer lower potential returns, while high-risk investments such as equities offer higher potential returns.
The risk-return trade off of the three major asset classes is illustrated below:
Historically, equities have generally outperformed bonds and cash over the long-term.
By understanding the risks associated with various investment options, you can choose investments that best match your personal risk tolerance level and time horizon.
The Benefits of Diversifying your Investments
Diversification is the name for the strategy of spreading of assets across different investment types.
With diversification you can aim to smooth out ups and downs in your returns because when one investment performs poorly, another might be performing well.
Careful diversification can help to improve the overall return on your investment portfolio.
You can easily diversify or spread your investments across:
Spreading your investments across different asset classes is also known as asset allocation. Studies show that over 90% of the returns from an investment portfolio can typically be attributed to asset allocation.
A smart investor will regularly review and rebalance an investment portfolio to ensure it is well diversified over time.
Dollar Cost Averaging
Dollar Cost Averaging means investing a fixed sum of money on a regular basis regardless of market conditions and whether security or unit trust prices are high or low.
To follow this strategy:
- You automatically buy less shares/units when prices are high and more shares/units when prices are low
- Over a period of fluctuating prices, Dollar Cost Averaging will reduce the average cost of units you purchase to lower than the market average price
How dollar cost averaging reduces average unit costs?
Benefits of Dollar Cost Averaging
- Reduces average unit costs by enabling you to benefit from market falls
- Eliminates the need to 'time' markets by letting you accumulate more units when markets are low and fewer units when markets are high
- Prevents you from investing a lump sum at the worst possible moment
- Encourages a long-term perspective and enables your investments to compound over time
The information contained in this website is provided for reference only and does not constitute any investment advice. Investors are advised to seek independent advice before making any investment decision.