When it comes to building wealth and securing your financial future, property investment has long…
Originally posted on: 19 May 2021
Latest Update: 22 September 2023
Would you like to generate additional income, grow your wealth and achieve financial security?
There are many reasons why people invest their money, but not everyone pushes through with investing.
Should the fear of losing money, the complexity of investing, or a lack of time, knowledge and money stop you from investing?
Most successful investors have made their wealth by taking advantage of various investment strategies and philosophies, which have helped them enjoy strong returns over the long term. While these strategies may be vastly different, these investors incorporate a few common principles when investment planning, contributing enormously to their success.
The good news is even a beginner or average investor can benefit from these same principles, allowing pretty much anyone to start building their wealth by investing according to financial advice from verified experts.
1. Invest as Early as Possible
2. Invest Frequently
3. Buy From High-Quality Companies
Is the business facing positive or negative industry trends?
4. Hold Onto Your Shares for the Long-Term
1. Invest as Early as Possible
Young Australians are increasingly recognising the importance of early investments. A study by the Australian Securities Exchange (ASX) in 2020 shows that about a million current investors are aged 18 to 24, and around 400,000 more are planning to begin investing within 12 months.
They’ve obviously seen the value of investing early and are motivated to build their future wealth. But what exactly are the specific advantages of beginning one’s investment journey sooner rather than later?
The Power of Compounding and Investing Early
Compounding is the process through which earnings from an asset, such as interest or dividends, are reinvested to produce more earnings over time.
The earlier you start investing, the more time your money has to grow, and the more interest you will earn. Your investment returns may be significantly impacted by this over time.
Let’s have an example using a compound calculator. Say, for example, you start investing $1,000 annually at the age of 25 and achieve a 7% annual return. Your investment will have increased to more than $214,000 by the time you turn 65 and are eligible for retirement. But if you hold off until you’re 35, your investment will only increase to about $102,000.
Incredibly, a difference of 10 years can more than double what you make.
The power of compounding, along with the benefits of starting early, can significantly impact long-term wealth accumulation. By initiating investing early, individuals can secure their financial future and achieve their long-term goals with confidence.
Time to Recover from Potential Losses
Investing inevitably comes with its share of risks, and markets can be volatile with short-term market movements. Your investments will occasionally lose value because of the trend of investments, particularly the stock market.
However, starting early allows you to have a longer investment horizon. The extended period provides you with ample opportunities to recover from potential losses and ride out market fluctuations without needing to make impulsive investment decisions. Let’s have a look at the housing market as an example.
The Australian housing market has experienced six periods of upswing and five periods of notable decline in the past 20 years. These downswings have been primarily caused by changes in credit conditions, negative economic shocks like the global financial crisis, or other events like the onset of COVID-19.
These downturns typically last for 25 months and have a -5.0% average peak-to-trough value fall. On the other side, market upswings typically last 30 months and result in gains of 24.8% on average. The cumulative gain in housing values increased from 145.8% in March 2021 to 190.5% in March 2022 over the previous year.
A longer time horizon allows you to ride out the 25-month downturns and take advantage of 30-month upswings should you want to sell your house. Otherwise, you can just sit back and watch its value appreciate through the years.
Increased Risk Tolerance
You may grow increasingly risk-averse as you age. This is because you would have less time to recover from losses. However, if you start investing early, you will have more time to take on more risk.
Early investors frequently have the advantage of higher risk tolerance. Because they have more time on their hands, they can afford to invest in assets with more growth potential, such as shares, which have historically provided stronger long-term returns despite short-term market movements.
The Australian share market has historically proven to be resilient and has always trended upwards over the long term – not just bouncing back but turning in strong returns. If you have the time to wait, having a higher risk tolerance can result in improved long-term returns.
Whether you’re a young professional or a parent planning for your children’s future, it’s crucial to start investing early to unlock the full potential of your financial journey.
You can start with a small amount of money. You don’t need to invest a lot of money to start seeing results. Even $100 per month can make a big difference over time.
Also, look to invest in low-cost index funds. Index funds are a great way to get started investing because they’re diversified and have low fees. An index fund is passively managed, unlike a managed fund. Plus index funds have consistently outperformed actively managed funds.
2. Invest Frequently
Investing frequently can be a prudent and effective approach to financial growth and stability. Dollar-cost averaging helps navigate market volatility, while the wide range of investment options available in Australia allows for diversified asset allocation tailored to an individual’s particular situation, preferences and risk tolerance.
Consistently contributing to investments helps achieve financial goals and secure a prosperous future. It’s never too early or too late to start investing frequently and take control of your financial destiny.
Embrace Dollar-Cost Averaging for Consistent Growth
Dollar-cost averaging is an investment philosophy that involves investing the same amount of money regularly, regardless of the market conditions and share prices. By averaging out your buying price, you can lower your investment risk.
With the same amount, investors purchase more shares when prices are low, and purchase fewer shares when prices are high. Over time, this leads to a reduced average cost per share and mitigates the impact of short-term market fluctuations.
Most Australians practise dollar-cost averaging through their superannuation, where a percentage of their salary is automatically sent to their preferred account and invested in ETFs, managed funds, or direct shares. This consistent, regular investment strategy remains constant regardless of market performance.
Understand that the objective of dollar-cost averaging is to eliminate the timing uncertainty rather than trying to predict whether the market will increase or decrease. Dollar-cost averaging increases your likelihood of long-term success by:
- providing a straightforward strategy to gradually invest in shares,
- instilling discipline, and
- helping investors avoid making emotional decisions.
Explore Diverse Investment Options
There are many different investment options available in Australia, so you can choose the ones that are right for you. Some popular options include stocks, bonds, ETFs, and property.
Stocks are shares in companies. Investing in the stock market allows individuals to become partial owners of publicly traded companies. With a diversified portfolio of well-researched shares, investors can potentially enjoy capital appreciation and receive dividends.
Bonds are loans that you make to companies or governments. Government and corporate bonds are fixed-income securities that offer regular interest payments and return the principal amount upon maturity. Bonds are generally considered less risky than shares and can provide stability to an investment portfolio. Australian government bonds have very low credit risk or the risk of default with a AAA credit rating.
Exchange-traded funds (ETFs) are baskets of shares or bonds in investment funds traded on stock exchanges, mirroring the performance of a specific index or asset class. ETFs can be a good way to get exposure to a particular market or sector without having to buy individual shares or bonds. They offer diversification and low expense ratios, making them an attractive option for many investors.
Property is another popular investment option in Australia. Property investment, particularly in residential and commercial properties can be an option to generate income and build wealth over the long term. Property investments can generate rental income and offer potential capital appreciation over time.
A good mixture of different asset classes between defensive and growth assets in consideration of your current financial situation, financial goals and risk tolerance will give you a diversified portfolio. Just remember that higher returns come with higher risks, and lower risks go hand-in-hand with lower returns.
Mitigating Market Risk
Investing early and regularly and diversifying your investment among the above-mentioned asset classes can help mitigate market risks such as:
- Investment risk: the uncertainty of achieving the returns according to your expectations.
- Inflation risk: the possibility that rising prices associated with inflation could outpace the returns delivered by your investments.
- Liquidity risk: the inability to find a buyer for an asset, limiting you from buying or selling whenever you want.
- Concentration risk: the potential for a loss in value of an investment portfolio due to exposure to a single risk factor or exposure to correlated risk factors.
3. Buy From High-Quality Companies
Another habit of successful investors is to buy from high-quality firms rather than succumbing to hyped-up shares or a backyard barbecue rumour that rarely delivers. Although there are many success stories, many more companies fall short of their potential and must fight tooth and nail to stay afloat.
To avoid this, invest in quality companies with solid business strategies, robust growth prospects, and long-term competitive advantages that will likely produce consistent returns over time.
Choosing which shares to buy can be challenging with many options and variables. Let’s simplify it for you with these six basic questions to ask before investing in a company.
Are the company’s profits increasing?
Company earnings are a company’s net profit, which is its revenue less operating expenses. Growth in earnings is a reliable sign of a successful company.
Earnings can be distinguished from revenue since rising revenue denotes rising sales. Although this is typically a good thing, profitability may suffer if costs rise. Earnings are a better measure of overall profitability since they take into account the costs incurred by the company.
You purchase a portion of a corporation when you buy a share. You now have the right to a portion of the company’s future earnings. Long-term returns to shareholders should rise if earnings are increasing.
A rising share price frequently reflects growing earnings. The price of a share partially reflects the shareholder’s expected future cash flows’ current value. Shareholders ought to be in line for larger cash flows if earnings are increasing. As a result, the share market is likely to place a higher value on a particular share.
Does the business make money?
A company needs cash to survive and grow. The term “cash flow” describes the money’s inflow and outflow. Money enters as revenue and leaves as costs.
Positive cash flow means a business has funds available after paying its expenses. This is encouraging since it gives the company room to invest in new opportunities and even give investors their money back through dividends or share buybacks. A negative cash flow shows that the company’s liquid assets are being depleted. This may warrant caution because a company will be deemed insolvent if it is unable to pay its debts.
Cash flow differs from earnings and profits. If money is invested in illiquid assets or unpaid accounts, a company may make a profit yet still have problems paying its debts. Alternatively, a company could have a lot of cash flow but not make a greater profit if its expenses go up or if it has a lot of bills to pay off.
Thus, investors must keep an eye on both cash flow and earnings. Companies can manage their debt, invest in expansion, and pay dividends thanks to cash flow. Although businesses may be able to borrow money or raise capital to cover short-term cash flow shortfalls, they cannot continue to operate with insufficient cash flows indefinitely.
How much debt does the company have?
Debt can be a useful source of funding for expansion, but if things don’t work out as expected, too much debt can soon become a burden. Debt financing enables businesses to grow quickly by leveraging modest sums of money into much larger sums. Additionally, interest payments are typically tax deductible.
However, businesses with debt must make money to pay off their debt. Regardless of the company’s real cash flow, interest must be paid. For companies with erratic cash flows, this may be problematic.
A company with a lot of debt might not be as resilient to a downturn as a company with less debt. This is because interest payments must be made regardless of changes in revenue or cash flow. When a business has debt, it must be able to pay it back.
The price-to-earnings (P/E) ratio of a business is calculated by dividing its share price by its statutory earnings per share (EPS). The relative value of a company’s shares is gauged by the P/E ratio. The P/E ratio, at its most basic level, shows the price the stock market is now willing to pay for a specific company’s earnings.
This can be used by investors to compare various companies in the same industry. For instance, Coles Group Ltd. (ASX: COL) would be “cheaper” if its P/E ratio was 21.86 and Woolworths Group Ltd. (ASX: WOW) was 28.41. This is because you have to pay less for each dollar of earnings at Coles than at Woolworths.
However, the ratio has limitations; it doesn’t perform well for newer businesses or those that aren’t currently turning a profit. Growth assets, such as companies with high P/E ratios, are frequently those whose future profit growth is anticipated by investors.
What is the track record of the management?
A company’s management has a significant influence over future direction and profitability. As a result, the investor must examine the quality of a management team.
Leadership value might be difficult to assess due to its intangible nature, but it is worthwhile to investigate. Management makes strategic decisions and is responsible for delivering value for shareholders. Many investors prefer that management has ‘skin in the game’ in the form of ownership stakes in the company. This can aid in aligning management and shareholder interests.
Examining management’s track record of returns can be beneficial in some cases. One method is to calculate a manager’s or management team’s return on investment. Return on investment is a profitability ratio that measures the return on an investment in relation to its cost.
Is the business facing positive or negative industry trends?
Trends are the upward or downward directions of variables in society, indicating growth, decline, and new products and services. They indicate the purchasing habits of individuals and businesses, indicating the prospects of different industries and companies. To assess the prospects of an industry or company, consider five key questions:
1. What cultural trends are likely to impact the industry or company?
Cultural trends involve changes in values, attitudes, and behaviours within specific groups or societies, which significantly impact the needs and wants that define the market for products and services.
For instance, the shift from acquisition to experience. People are less and less interested in acquiring things for the sake of having things, and more and more interested in experiences. This results in people purchasing high-quality items that support their most important experiences, while settling for lower or modest quality items when they are not.
It is crucial to monitor early signs of cultural values and behaviours, and consider new needs and wants that may increase, as well as existing needs and wants that may decrease or disappear.
2. What demographics are likely to impact the industry or company?
Demographic trends refer to changes in a population based on age, sex, race, and ethnicity, as well as socioeconomic changes related to marriage, birth rates, death rates, education, employment, and income. These trends are closely related to generations.
For example, analysts have pointed out that Baby Boomers are resisting ageing the way generations before them did. As a result, the market for products and services for Boomers will include things that allow them to stay younger longer.
Other analysts point out that Millennials are resisting growing up the way generations before them did, and the market for products and services for Millennials will be different at every stage of life than for earlier generations.
These trends can help make reliable predictions about the market for products and services. It is crucial to pay attention to different demographic groups, their interests, concerns and needs and identify which companies are addressing them.
3. What economic and market trends are likely to impact the industry or company?
Economic trends involve changes in the economy, including business formation, job creation, consumer confidence, gross domestic product, personal savings, business investment, economic cycles, and business and personal debt.
When favourable, these trends help existing and new companies thrive, while unfavourable trends cause challenges for existing companies and new companies. Economic trends indicate the emergence of new leading sectors that will dominate the economy for decades, while previously dominant sectors recede.
For example, railways were a notable industry in the middle to late 1800s. Automobiles were a dominant industry for most of the twentieth century. In the late 1990s and early 2000s, personal computers and information technology became a dominant industry.
Soon, new industries will take the lead. Artificial intelligence, robotics, bio-individual medicine, and healthcare technology, are expected to emerge in the next economy affecting the entire market.
4. What technological trends are likely to impact the industry or company?
Two elements influence technological trends:
- the need for goods and services that call for innovation and discovery, and
- advancements in science and technology that enable new goods and services.
These developments frequently combine improvements in science and technology with modifications in consumer and industry demand and adoption.
For example, software for desktop computers is dwindling while software for cloud computers is expanding.
Technology advancements like broadband access and distributed computing software have made it possible to have nearly unlimited bandwidth availability. Customers now value the ability to work from different places, ensuring access to applications and data on many devices, as a result of changes in demand.
It is critical to pay attention to early indications of technological and demand changes because this tectonic shift has happened both gradually and quickly. It is crucial to think about which new technologies will succeed or take hold, and which ones will fade away or falter.
Although short-term volatility can be frightening, it is essentially only a step in the process. Instead, one of the best methods to increase your wealth is to buy shares of reputable companies with a long-term perspective and hold onto them.
If you are patient and discerning enough, you will hopefully be rewarded. It’s crucial to remember that even while some shares may have pullbacks over time, selling out in any of these situations could result in the loss of significant potential future gains.
With the stock market, there are two main schools of thought in the financial world: short-term trading and long-term investing. Short-term traders aim to make money quickly by timing the market – buying and selling shares; while long-term investors focus on quality shares and holding them for the long term, despite market fluctuations.
Long-Term Investing and Its Benefits
A vast majority of financial planners recommend long-term investing. The key principle behind this approach is to achieve capital growth by allowing your investments enough time to grow and benefit from the power of compounding.
Frequent buying and selling of shares entail transaction charges and fees, which can reduce your overall returns. Long-term investors benefit from lower transaction costs, which reduces the cost of their investment.
The share market is prone to fluctuations, and short-term traders are prone to making emotional financial decisions during times of volatility. Long-term investors can afford to ride out market fluctuations while remaining confident in their carefully researched choices.
Potential Pitfalls of Short-Term Trading and Market Timing
While short-term trading and market timing may appear appealing to some, they are fraught with risks and pitfalls:
- Increased Stress and Time Commitment: Short-term traders must constantly monitor market conditions, examine data, and make quick judgements. This way of living can cause tension and anxiety, as well as negatively impact one’s mental health.
- Market Timing Is Tough: Forecasting the market’s short-term moves is notoriously tough. Even seasoned specialists frequently fail to precisely time the market. Trying to do so may result in losses and missed chances.
- Higher Taxes: In Australia, keeping investments for more than a year qualifies for a 50% capital gains tax break. However, short-term trades are taxed at the individual’s marginal tax rate, resulting in larger tax loads on gains.
5. Reinvest Dividends
Dividends are regular cash payments distributed by companies to their shareholders, typically based on their profitability and financial performance. They can provide a steady stream of income that can be used to supplement retirement savings, pay for living expenses, or simply grow your wealth over time.
Think about reinvesting dividends. Reinvesting dividends is a great approach to increasing your wealth over the long run if you aren’t investing for income. You will probably have better returns, more security, and a lot of money saved up that you can use when you retire.
The Significance of Dividends
The significance of dividends lies in their consistency, which helps provide a steady income stream even during market downturns. By investing in dividend-paying shares, you need not sell investments for income, allowing you to hold onto your investments for more extended periods and potentially benefit from long-term capital appreciation.
Moreover, dividends often outpace inflation, safeguarding the purchasing power of investors’ income. As companies grow and increase their dividends over time, investors can experience a compounding effect, further enhancing their overall returns.
There are two main ways to reinvest dividends:
- Dividend reinvestment plans (DRPs) allow you to automatically reinvest your dividends in more shares of the same company. This can help you to grow your investment over time and compound your returns.
- Manually reinvesting dividends involves taking your dividends and buying more shares of the company yourself. This gives you more control over which companies you invest in, but it also requires more work on your part.
Tax-Efficient Dividend Investing in Australia
There are several strategies that you can use to manage dividend income in a tax-efficient manner in Australia.
One option is to invest in companies that pay franked dividends. Shareholders get their share of the tax paid by the company in the form of “franking credits,” which are added to the profits they receive. This means that you will only have to pay the remaining tax on the dividends, which is usually at a lower rate.
Another option is to invest in dividend-paying Exchange-Traded Funds (ETFs). ETFs allow you to get exposure to a diversified portfolio of dividend-paying companies without having to pick individual shares.
Ready to Build an Investment Portfolio?
Investing can be intimidating at first, but when you stick it out, you’ll enjoy massive returns that you wouldn’t have been able to get elsewhere. Incorporating these tips with your financial planning along with the help of a financial adviser, you’ll soon become a good investor with a high net worth.
While investing can seem complicated and time-consuming, it doesn’t have to be that way with knowledge and expert guidance. Whether you’re young or old, it’s never too late to start investing for your future.
Need investment advice? Coastal Advice Group is to help you tailor your investment plan and build your portfolio. Our financial advice team can help you establish direction for your investments to achieve your financial and lifestyle goals.