Seven principles of personal investment

MANY Australians have a very narrow approach to personal investment. In most cases, it simply involves gearing into rental properties and buying one or two blue chip shares via a privatisation (Telstra or Commonwealth Bank) or demutualisation (AMP).

Completing the picture is compulsory superannuation, although many people don’t know how much they have in super or how it is invested. Having the money ‘locked away’ until retirement is one reason for this apparent disinterest.

For investors who wonder if they are taking a suitable path, a handy exercise is to compare their approach with the seven basic principles of investing put forward by financial services group Perpetual.

Brad Holmes, Perpetual’s national manager – investments, believes too few Australians recognise or routinely adopt these principles.

Rule number one is to be an investor, not simply a saver. A saver focuses on the money that they are ‘putting aside’ while an investor focuses on the returns they can make over a period of time.

The second rule is to manage risk, rather than trying to avoid risk.

“While Perpetual always recommends investment in growth assets, particularly shares, for long-term investors we recognise that this is not a risk-free approach,’ Mr Holmes said.

“However, this risk can be managed and is preferable to taking a seemingly no-risk approach, such as investing totally in cash which, over the long term, is likely to mean that capital is eroded by inflation, and so is really at risk anyway. It is just a different type of risk.”

A third rule is to invest for the long term. Mr Holmes said too many investors were swayed by short-term events and made short-term decisions.

Even when people retire, say at age 60, they still have a life expectancy of nearly 30 years and should therefore retain a long-term investment focus.

A fourth rule is to invest in quality shares. For long-term investors, shares almost always will generate the best long-term after-tax returns.

Mr Holmes said quality shares were characterised by growing income streams, stable experienced management and conservative debt levels.

However, the case of Pacific Dunlop is salutary. In the early 1980s it was considered one of the bluest of blue chip stocks, but since then has run into a succession of problems and generated big losses for many investors.

The best way to manage this risk is to follow rule number five – diversify. The individuals who lost their life savings in failed finance brokers should have adhered to this rule – don’t put all your eggs in one basket.

Similarly, individuals who invest all of their savings in a single rental property, or up to three shares, are not sensibly diversified.

Rule number six is to have an investment strategy covering issues like how long you will be investing for, the rate of return you want to achieve and the level of risk you are prepared to take.

Mr Holmes said an investment strategy was the tool long-term investors used to ensure they stayed on track.

The final rule is to focus on after-tax returns.

“It is usually a mistake to invest solely for tax reasons but there are a number of ways of investing tax intelligently,” Mr Holmes said.

These include buying shares that pay ‘franked’ (ie tax-paid) dividends, splitting investment income with your spouse, and using gearing techniques (i.e. borrowing to invest) when appropriate.

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