The basics of investing

— 8 min read

There are many people around the world, just like you, who started investing with the intention of growing an asset base that could help buy a house, pay for children’s education, supplement their income or grow that nest egg to one day live off in retirement.

As a new investor, you probably have a lot of questions, like “Will I be ok?” or “Will my money last long enough?”. These are completely normal and very common questions directly related to investors concerns, however, there is perhaps a more prudent question which you should be asking, and that is “Where do returns come from?”.

Broadly speaking, there are three distinct groups that publicly traded investments fit into: fixed income, equities and property.

Fixed income – also known as bonds, are defensive assets which are considered to be of lower risk than equities and provide regular interest payments over time, however they do not provide any capital growth potential.

Equities – also referred to as shares, can provide both income and growth over time.

Property – can be in the form of residential or commercial and both variants offer income and growth potential.

Lucky for us, the academic community have been studying how returns are determined from these different asset classes for decades. There are two dimensions determining fixed income returns, which are term and credit. There are four dimensions which determine the returns of shares, which are the market, company size, relative price to competitors and profitability. For property, there is just a single dimension that determines the return, being the market itself.

Whether you achieve these different returns is largely based on ensuring you hold a diverse mix of these investments with a long-term and disciplined mindset.

There are primarily two approaches you can take when considering how you plan to invest:

  1. The first involves making future predictions on which direction markets and securities will go, trying to pick winners and avoid losers. Under this approach, you are likely to have a very concentrated portfolio that forgoes diversification which would require regular trading and constant speculation.
  2. The second approach involves the school of thought that investing should not involve forecasting, but rather accept that security prices are fair. Under this philosophy, trading would be minimal and diversification is embraced as a way of reducing portfolio risk.

Generally, we would consider the former approach to be ‘speculating’, or ‘gambling’. The academic research considered the latter approach to be ‘investing’ and suggests that behaving as a true investor provides greater opportunity for a successful investing experience. Speculating can certainly provide considerable rewards if you get it right, however there is a very real risk of underperforming using this approach.

Understanding the psychology of investing can play a huge part of maintaining a long term, disciplined approach over time. If you get spooked by short-term noise and believe you are best to reposition your portfolio to profit from various ‘news events’, you must understand this is speculation. Embracing the principles of true investing greatly improves the chances of achieving all the elements of returns available through the capital markets.

For more info on the psychology of investing, read Recognising and managing biases in financial decision-making.

In summary, combining an evidenced based approach to investing with a disciplined approach over time will provide you with a better chance of having a successful investor experience.

If you would like to learn more about investing and building a portfolio that is right for you, please contact one of our experienced financial advisers for an obligation-free complimentary initial consultation.

* The information contained in this site is general and is not intended to serve as advice. DPM Financial Services Group recommends you obtain advice concerning specific matters before making a decision.

 

Authors

Christian Seeley

B. Comm (FinPlan)

Consultant
Melbourne

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Christian joined DPM in 2014, bringing with him more than 4 years industry experience. With a strong background in paraplanning and preparing statement of advice documents, Christian specialises in creating detailed cash flow and net asset projections to help clients plan appropriately for their future lifestyle and financial objectives.