Types of investments

After evaluating what you expect from an investment, you should look into the types of investments that suit your requirements. This chapter outlines a few of the most common investments available.

Cash accounts

Banks and similar financial institutions provide transaction accounts where consumers can save their money. These accounts earn a little bit of interest, but they mostly exist as storage facilities rather than investment accounts. To invest rather than save, an investor would need to look for accounts with a high interest rate or consider putting their money in a term deposit.

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High interest accounts pay a return above the inflation rate, are low risk and easily accessible. Investors will not earn the highest return, but the convenience of having liquid assets may suit your requirements more than other investments. Most high interest accounts allow you to access your money at any time although the fund may offer a higher interest rate if you keep more money in the account for a longer period.

Term deposits are a type of high interest account where you keep money in the investment fund for a set period in order to earn a set amount of interest. Because you cannot access your money throughout the term, term deposits usually pay more than high interest funds because you sacrifice convenience and accessibility for the higher rate.

Shares represent partial legal ownership of a corporation and the return will relate to the financial position of the company. If the corporation performs well, then the value of the shares will go up; if the corporation is in financial trouble, the value will decrease. When the business makes a profit, they will pay dividends to the shareholders but if the business concedes a loss, it only affects the value of the shares.

Much of share trading is market confidence - if investors feel confident about a company's ability to perform well, then they will invest in that company. When demand for a company's shares increases, the value of the shares will rise. The fluctuation (rise and fall) of the share market makes short-term investment risky. However, by observing trends and investing in companies with a solid record of accomplishment, shares make a great long-term investment.

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Investing in shares requires a substantial amount of research about the company's performance compared to other companies and an understanding about how the market works. An investor's return can be significantly high depending on a business' performance, especially in cases where the investor takes a risk in buying shares in a company that other investors have ignored and the company performs unexpectedly well.

Most investors trade shares via the stock market - in Australia, the Australia Stock Exchange (ASX) - and may use the services of a stockbroker, who will provide advice and buy and sell shares on an investor's behalf for a brokerage fee. Some shares are available to trade online, which means that you can be your own broker.

Bonds and debentures

Bonds and debentures are both types of fixed-interest investments where the issuer assumes a debt to the investor. A bond is where an organisation assumes a debt to a bondholder by promising to repay the principal, plus interest. The issuer makes periodic repayments of the principal plus interest in the form of coupons. At the maturity date, usually several years from the time of the initial outlay, the investor will receive an additional return. If the issuer cannot make repayments, the investor can make a claim on their assets, making bonds a secure investment.

Debentures work in a similar fashion but have less security because the issuer can exclude certain assets from a claim, should they default on their repayments. The decreased security means that debentures may attract a higher interest rate.

Both bonds and debentures are reasonably secure. This is because by lending money to a company or organisation the investor is a creditor and therefore possesses certain rights to retrieve their money.

Property

Many investors like to outlay money in residential or business property because they gain something tangible in return. There are two main ways to make money from property; an investor can earn an income from renting out the property or, if the selling price is higher than the initial purchase price, the investor makes a capital gain. If the investor sells the property for less than he or she paid for it, this is a capital loss.

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Because property investors receive something tangible, this form of investment is secure and investors can make a significant amount of money. The value of property is subject to market demand, however, which may depend on factors such as location or housing trends.

One of the main drawbacks of property investment is the amount of research required and the cost and paperwork involved. Buyers of property must pay stamp duty. This is a type of tax imposed by each State or Territory for the transfer of land, and fees for conveyance, transferring property titles (deeds) from one party to another. Stamp duty is calculated as a percentage on a scale, so the final amount will depend on the value of the property. Generally, stamp duty represents several thousand dollars, in addition to the few hundred dollars you might pay for conveyance.

Another disadvantage is that it generally takes years to make a capital gain from property and the investment is not liquid, meaning it takes a long time to obtain the return.

Managed funds

A managed fund is one where a financial institution invests money on your behalf, along with the money from other investors. This collective investment allows them to offer greater diversity and therefore a greater degree of security than individual investments. Investing in a managed fund also means that you do not need a minimum investment for each of the ventures in which you wish to invest.

The investor can specify the mix of investments or let the fund manager decide the spread. The fund usually pays interest that corresponds with the mix of investments - some high-risk and some low-risk, as well as long- and short-term ventures, which means you will receive a higher interest rate than secure investments but more security than high risk investments.

Superannuation is a type of managed fund where a superannuation company invests contributions from members until the worker can make a claim at retirement.