Investing: Back to basics

The past few years have shown us all that share markets can be volatile creatures.

The Australian share market, for example, fell 53% from its peak of 6,800 in late 2007 to a low of just under 3,200 in March 2009. Since then, though, it has crept back up to around 5,400 at time of writing. 

As confidence gradually returns, people are asking: is now a good time to invest in the market? While nobody knows what tomorrow will bring, the key to answering this question hinges on acknowledging three aspects of your personal financial circumstances:

• your investment goals
• your investment time horizon
• your investment risk tolerance.

Investment goals

Understanding your investment goals can make all the difference to deciding whether to invest now or to keep your cash handy. Are your goals short-, medium- or long-term in nature?

For example, saving money for a house deposit for a year or two is generally best kept in cash. However, if your goals are medium- to long-term (say, five years or more into the future), then perhaps investing in the share market now may be appropriate.

Investment time horizon

Being realistic about the intended timeframe for your investments is crucial to making a suitable investment choice. If you are looking for a short-term investment, the general rule of thumb is to keep your funds in defensive assets such as cash or bonds.

If you are looking to invest for the longer term, growth assets such as Australian and international shares and property may be more appropriate. However, if you have a short-term horizon, investing in these asset classes is generally not recommended. This is because volatility of these assets means there is a greater chance that you could receive less back at the time of withdrawal than what was originally invested.

Investment risk tolerance

Most people will say that the best investment is one that has the highest returns. From a financial planning perspective this is only part of the picture. The optimal investment choice should take into account not only your investment goals and investment time horizon, but also your ability to tolerate investment risk.

Almost all aspects of investing involve risk. At one end of the spectrum, some people may be very comfortable with the ups and downs of having a portfolio predominantly exposed to shares and property. Others may prefer the stability of a portfolio oriented towards cash and fixed income securities. The risk with that type of investment is that it may not keep pace with inflation, particularly after tax. A more balanced investor will have a mix of all of these asset classes in their portfolio.

All things considered, the best investment for you will be the one that you feel comfortable with, while providing for your financial needs.

If you are unsure about your next investment step, please contact your financial planner for personal advice.