What do you want from your investments?

Press, 17 May 1989, Page 13

What do you want from your investments?

Sheryl wf"! Nichollsgn | g|

MONEY Manßemenfi

One of the first things for you to consider when investing is security, how prepared or able are you to take risks. Your investments should be structured so that you are not lying awake at night worrying about possible losses. The ability to take risks depends on factors such as how old you are, what sort of a person you are, and how much money you have to invest. Those of us with small amounts of money tend not to want to take risks, likewise those close to or in retirement. A loss in this age group can be devastating as capital replacement will be- nearly impossible. Some investors divide their money so that some is invested in a risk-free area, and some in a riskier area for higher returns. A useful rule of thumb is, high return equals high risk, low return equals low risk. This is known as the risk return equation. The possibility of loss is the price the investor pays for a high return, or the low return on a secure investment is the price the investor pays for greater security. To give you a guide, the following forms of investment are ranked from low to high: Cash/bank deposits, bends, equities, futures/options, betting on horses. Your financial plan should suit your risk and

return profile. There are many different ways to manage money, some involving more risk than others. You need to be sure that your money is being managed in line with a level of risk you find comfortable. Clearly, the better the management of your money, the higher the return you may receive for an acceptable risk. Inflation is discussed constantly. There are many different theories on its causes. It is, however, generally accepted that inflation is caused by an increase in the amount of money available. Simply put, inflation is the erosion of the spending power of your money. For example, $lOO in 1970 was worth the equivalent of $l7 by 1988. In times of high inflation, the value of an asset increases as the value of the dollars it takes to purchase that asset decreases. Any investment you make must take inflation into account. You will need to earn enough to cover inflation, pay tax, and make a further percentage so that your money is working for you. Like inflation, taxation is an important factor to take into account when planning investments. By choosing a suitable investment vehicle the effects of taxation can be minimised. There are three areas under our present taxation regime where we can legitimately exercise an

option to reduce the tax we pay.

In this country capital gain is not taxed, so an investment which gives a capital gain is tax-free. An example of this is a Property Trust where no income is paid to the investor. (Unit Trusts will be discussed in a future article). People who hold shares and are receiving dividends, or who are receiving income from some unit trusts, can claim a tax credit. This comes about through “imputation.” Previously, companies paid tax on profits then distributed dividends. Dividends were then taxed in the hands of the recipient. Imputation means that now the recipient can claim a tax credit for the tax the company has previously paid.

The third investment which can minimise the tax an individual pays is that of a life bond (also covered in future articles). Life bonds are taxed, but the tax on these is paid by the life company on the investor’s behalf. When planning your savings you will need to decide whether you want income or capital growth. Certain types of investments provide a reliable source of income now or

in the future, e.g. money on deposit with a finance company or government stock. These are called income-yielding investments. Other investments may provide little or no income, but the value of the investment itself may rise, that is the capital you put in will have increased in value. For example, imagine you bought Brierley shares at $5 each. Each year you received a dividend, say 3c a share. That was your income. Some years later — as in the share market boom — the market price of your share may have risen to $7. If you sold your shares the extra $2 above the initial purchase price was your capital gain. The last factor I wish to discuss is certainly not the least important in planning your investments. Again, this applies whether you are investing directly or indirectly. This is “portfolio balance” — asset spread. This may sound a little esoteric, but is simply a variation on the "don’t put all your eggs in one basket” theme. A conservative investor would create a portfolio to a pyramid, with low risk investments in the broad base in the bottom, medium-risk in the

middle, and the point of the pyramid being the small exposure in highrisk investment. This “diversification” reduces the risks inherent in investment. If one sector goes down in value the effect will be lessened by increase in value, or return of the other investments. A spread of investments increases your chance of return. If one does well you can participate in profits without having risked all your money.

The four main investment sectors are — property, equities (shares), fixed interest, cash. You should be aware that the balance between these areas may need to be altered as a result of changes in your needs, or changes in the economic environment. A second form of diversification is international investment. The population of New Zealand is equal in size only to that of, say, the city of Birmingham. Before 1983 we were restricted by legislation from investing overseas. That is now not the case. Why should you invest overseas? It will give you a spread of risk by being in a mix of markets and currencies. Markets and currencies generally move at different times. If, for example, the New Zealand market is not moving, maybe the United States is. In New Zealand, because our economy is so small, we cannot invest in expanding sectors such as pharmaceuticals or robotics. Investing overseas also allows us access to broader property markets, and interest rate markets. ♦ * * In my next article I will discuss life bonds and unit trusts. In the final article of this series I would like to respond to readers’ queries. Please write to Sheryl Nicholls, P.O. Box 5535, Dunedin, with your question, supplying name, address and telephone number. Names and addresses will be kept confidential, unless requested otherwise. Of necessity, in an attempt to keep explanations simple, I have generalised. This means that exceptions which are prevalent in the financial world have been ignored. These articles are intended to be a simple, general guide. Each person should consult his or her adviser to clarify their own situation.

Portfolio balance simply means don’t put all your eggs in one

basket.