Challenger - Investment basics

Investing is all about making your money work harder for you now, to ensure your financial growth and security in the long term. Whether you're a first time investor, or the holder of a blue-chip portfolio, the basic elements of investing are the same.

Asset classes

Asset allocation

Managed funds

Diversification

Dollar cost averaging

Compounding interest

Asset classes
Asset classes are usually classified according to the type of returns they provide. Some assets primarily produce income while others provide capital growth. Income assets include fixed interest and cash investments and are suitable for shorter-term financial goals, while growth assets include shares and property investments and are suitable for longer-term financial goals. Growth assets will generally produce more volatile returns, which can sometimes be negative over the shorter-term, while income assets tend to produce more predictable returns.

Another important factor to take into account is your investment time horizon. While cash may seem like the safest option, you may miss out on opportunities to grow your capital. One of the negatives of a low inflationary environment is that cash rates remain relatively low. This means you can't just put your money in the bank and expect to earn an income from it. That's why it is important to consider growth-type assets as part of your investment strategy.

A brief overview of the various asset classes and risk/return profiles is provided below.
Cash investments include debt securities such as bank bills, certificates of deposit and treasury notes that generally have a life span of less than 12 months. Cash investments usually offer a lower interest rate than bonds given the shorter investment period.

Fixed interest investments are income assets although they can provide some capital growth. Fixed interest securities usually offer higher yields than cash given they have a longer investment period - usually between 1 to 10 years. The longer the life of the bond, usually the higher the interest rate paid. Profits can be made from fixed interest investments when they are traded on a secondary market.

Equities (shares) are a growth asset as they generally provide the potential for strong capital growth over the medium to longer term (3 to 6 years). Shares may also provide a tax-efficient income stream through dividend imputation. Dividend imputation is a simple idea, although it becomes a little complicated in practice. In essence, dividend imputation means that if a company has paid tax on its profits and distributes these profits to shareholders as dividends, the shareholders who are residents for Australian tax purposes may be entitled to a credit against their tax, equal to the amount of tax already paid by the company.

Property refers to investments in direct (real) property as well as listed property trusts. Direct property includes a number of sectors such as residential, retail, commercial, industrial and tourism and leisure, and within each of these are sub-sectors based on location, grading and use. Listed property trusts (LPTs) are traded on the stock exchange, while their underlying investment is direct property. LPTs can be a good way for retail investors to invest in one or more of the property sectors and access the large, quality properties that are usually the domain of institutions and developers.

Multi-sector funds can offer the best of both worlds by investing across a range of asset classes including Australian and international shares, property, fixed interest and cash. Multi-sector funds are designed to meet a variety of risk/return profiles. For example, some funds focus on providing an income with some capital growth, while others will focus on providing capital growth.
Asset allocation

The distribution of your investment dollars amongst different asset classes is referred to as asset allocation. The asset allocation for any investor will depend on several factors including your desired returns, preferred investment time frame, long-term income earning ability, tolerance to risk, the need for cash flow from your investment portfolio and general market conditions.

Managed funds

What are managed funds?
With such an incredible range of investment options available today, managed funds offer a viable alternative for many investors.

A managed fund is essentially a large investment 'pool' where many investors combine their money to access a range of different investment assets (e.g. equities, property, fixed interest). This pooling of funds enables a fund manager to use 'critical mass' or 'buying power' to great advantage.

When you invest in managed funds you will be issued with units and these units represent your stake in the fund(s). The price of these units may increase or decrease, depending on the value of the underlying investments in a fund. A managed fund can be beneficial for investors for several reasons. Risk is spread through diversification and instead of needing to invest thousands of dollars to construct a diversified portfolio (as compared with buying shares alone), investors can invest smaller amounts, starting with as little as $1,000 in order to achieve diversity.

Managed funds typically invest in five main asset classes: Australian and international equities, property, fixed interest and cash. Some managed funds may invest in only one of these asset classes, while others, sometimes referred to as 'balanced' or 'multi-sector' funds, hold diversified portfolios with a mixture of investment asset classes.

While some investors like to actively track their stock portfolio and trade regularly to maximise profits, many investors want less involvement in their investments. With a managed fund, there is less stress involved for the investor as fund managers do most of the work. They make the hard decisions about asset allocation and closely track the range of investments in those funds.
What are unit prices?

Unit prices are typically issued each business day. Both an issue price and withdrawal price are calculated. An issue price is the value of a unit when you apply to make an investment in a fund and the withdrawal price is the value of a unit when you withdraw your investment in a fund. The difference between the issue and withdrawal price is known as the buy/sell spread. This spread typically represents an allowance per unit for:

the cost of buying assets within the Fund; and
the cost of selling assets when a unitholder withdraws units,

so as not to disadvantage unitholders as others enter or leave a Fund.

Diversification
We've all heard the expression 'don't put all your eggs in one basket'. That saying is just as applicable when referring to your investment strategy. Diversifying your investments (effectively spreading your investment across more than one asset class) can reduce your exposure to risk and potentially achieve more consistent returns. Diversification works on the principle that different asset classes perform well at different times. See the table below of asset class returns over the last 10 years.

Asset class returns

As at	Australian Shares	International Shares	Aust Listed Property Securities	Australian Fixed Interest	Cash
31/12/95	20.75%	26.05%*	14.28%	18.63%	8.06%
31/12/96	14.54%*	6.24%	14.24%	11.87%	7.57%
31/12/97	12.15%	24.67%*	21.76%	12.23%	5.63%
31/12/98	9.75%	32.34%*	18.37%	9.54%	5.14%
31/12/99	19.52%	19.91%*	-4.20%	-1.22%	5.01%
31/12/00	6.31%	2.19%	18.79%*	12.08%	6.27%
31/12/01	10.49%	-9.96%	14.99%	5.45%	5.24%
31/12/02	-8.64%	-27.44%	11.85%	8.81%	4.77%
31/12/03	14.96%*	-0.77%	8.81%	3.05%	4.90%
31/12/04	27.92%	9.96%	32.18%	6.96%	5.62%
31/12/05	22.45%*	17.39%	12.70%	5.79%	5.73%
31/12/06	24.51%	12.02%	34.05%*	3.16%	6.04%
31/12/07	16.21%*	-2.14%	-8.94%	3.46%	6.73%

* Best performer

Performance information is historical; performance returns may vary; past performance is no indication of future performance and neither your investment capital nor any income is guaranteed.
Source � Bloomberg. Asset class returns based on performance of the following benchmark indices:
Australian Equities - S&P/ASX 300 Accumulation Index
International Equities - MSCI World (ex Australia) Index
Australian Listed Property Securities - S&P/ASX 300 Listed Property Trust Accumulation Index
Australian Fixed Interest � UBS Australia Composite Bond Index (All Maturities)
Cash - UBS Australia Bank Bill Index

As you can see, in the 10 years to 31 December 2004, the top performing asset class varied across International shares, Listed property and Australian shares. Therefore, it is usually preferable to construct your portfolio using an appropriate mix of funds with exposure to investments across all or most markets. This approach can help to manage the highs and lows of economic and investment cycles by balancing the returns of lower performing markets with the returns of higher performing markets.
It is also important that your investment portfolio is diversified within, as well as across, asset classes. For example, your international equities portfolio should contain a mix of equities from different regions, countries and sectors. This limits your exposure to the possibility of an economic downturn in a specific sector, country or region.

Dollar cost averaging

The secret of regular investment is dollar cost averaging
Regular saving is one of the most important aspects of achieving any financial goal in life -whether it's your child's education, a home deposit or an overseas holiday. It is also the first step in building up your wealth and maximising the earning potential of your investments.

At first, the prospect of saving such a large amount of money may seem daunting. One of the easiest ways to achieve your goal is by contributing to a regular savings plan in a managed fund, preferably by putting away a certain amount each month before you have a chance to touch it. The theory here is what you don't see you won't miss.

Using a dollar cost averaging strategy means you don't have to be an investment genius and know how to time the markets. All markets have times when they go up and times when they go down and this is reflected in the unit price. Common sense tells us to buy when prices are low and sell when prices are high, however predicting market movements is no easy task. Investing a set amount on a regular basis, no matter what the unit price is, can average out market fluctuations and the overall cost of your investment.

This is because if you invest in a managed fund, when the sharemarket falls your money will buy more units. Conversely, if the sharemarket rises you buy less units.

For example, imagine you had $100 to invest regularly each month. In one month, unit prices might be high, say $10 per unit - in this case you would only buy 10 units (10 units x $10 = $100 monthly investment). However, the next month, the unit price drops to only $5 per unit. Now, still using your regular $100 investment, in this month you are able to buy 20 units (20 units x $5 = $100 monthly investment). Over the two months, by regularly investing, you have been able to even out the highs and lows of the investment cycle. Of course, this example is hypothetical and to gain real benefit from dollar cost averaging, you need to invest regularly over a longer period of time.

It is important to remember that dollar cost averaging does not guarantee profit. However, it may help you to use market fluctuations to your advantage over the long term.

Compounding interest
Most of us plan to save money, but it's so easy to put it off, find an excuse and claim, "something else came up". However, next time you're thinking of delaying starting your savings plan, think of these two words�compound interest. Compound interest refers to the reinvestment of the interest you have earned on an investment. Over time, by not withdrawing the interest that grows on your investment, the investment will attract even more interest. It's interest earning interest!

The information on Challenger websites is general in nature and does not take into account your personal circumstances, financial needs or objectives. Before acting on any information, you should consider the appropriateness of it and the relevant product having regard to your objectives, financial situation and needs. In particular, you should seek independent financial advice and read the relevant Product Disclosure Statement or other offer document prior to acquiring a financial product.