Wednesday, 17 June 2015

Whether we’re talking about you, me or Warren Buffet, we can all only invest in the same things. Typically these are assets such as shares, bonds, cash, property and infrastructure.

The point I’m going to make is that once you cut through the noise and are clear on what your investment goal is, the theory behind investing is fairly simple. Ultimately, it comes down to understanding asset classes. When we invest our money, we are in effect simply lending it out to someone in the expectation of a return (and/or our money back) at some point in the future. When we lend our money out we are buying a future stream of investment returns.

These return streams can either be more stable (in the case of cash and bonds) or less stable (in the case of shares), with property, infrastructure and alternatives offering us some combination of the two. And the trade-off is that an asset class offering a more stable return stream is also likely to offer lower returns, and vice versa.

But in my view, the key to understanding asset classes is to understand their income payments and the economic environment that produces those payments. We can simplify things further by splitting asset classes between growth and defensive assets. Growth assets, like shares, generally perform better when economic times are good, while defensive assets, like bonds, generally perform better when economic times are not so good. Nothing new here so far, right?

In terms of income payments, when you buy a share in a company, you receive dividends from that company. Similarly, rent is income from property. If you own a shopping centre, you receive rental payments from each business in your centre. If you invest in infrastructure assets such as toll roads, the income you receive is in the form of the tolls paid. With bonds, income payments are called ‘coupon’ payments; when you buy a bond, you lend money for a set period of time (during which you receive these payments) at the end of which you also get you initial capital amount back.

Generally speaking a stronger economy leads to higher share prices and interest rates, but lower bond prices. Conversely, slower economic activity leads to lower share prices and interest rates, but higher bond prices.  Of course, this isn’t always strictly going to be the case. But, generally it’s what you can expect. And with this you can cut through a lot of the noise.

The challenging part of course, and what is essentially the holy grail of successful investing, is mixing these asset classes in a portfolio in such a way that it achieves the best trade-off possible between earning a return target while also being able to sleep soundly at night. Further, being able to do this consistently is another part of the challenge.

 

The views of the author and those included in the responses to comments posted on this blog are not necessarily the views of QSuper. This information is for general purposes only. It is not intended to constitute advice and persons should seek professional advice before relying on this information.

Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.

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