September 10, 2014

Investment Strategy: Objective based investment strategies

People invest so they can have more money in the future than they have today. However, they have different objectives which generally fall into three categories: preserve capital; generate income and grow capital, as Nick Ryder, NAB Private Wealth Investment Strategist reports.

Why do people invest money? In simple terms, it’s so they have more money in the future than they have today.

When we sit down with our clients and work with them to understand exactly what they’re seeking to achieve with their investments, we often discover a range of different objectives. But in general, investor objectives fall into three categories: Preserve capital, generate income and grow capital.

A summary appears below:

Capital Preservation

Investors with a capital preservation strategy primarily want their capital to remain intact with a high degree of certainty. They’re less concerned with income and growing their capital. The timeframe over which the capital needs to be preserved will determine the precise blend of investments. However, for shorter periods, cash investments and bank term deposits are usually the most suitable choices. This is because, in Australia, bank deposits of up to $250,000 are guaranteed by the Australian Government.

For longer time horizons, fixed income securities – such as bonds that are highly rated by a credit ratings agency – are the most suitable. For example, 10-year Australian Commonwealth Government bonds are rated AAA by Standard & Poor’s and, although the yield on these bonds is only about 3.5% per annum, there’s an extremely high probability that investors will get their capital back. We also find that some investors want to preserve the “real” value of their capital. This means that they want their capital to be protected against a loss in purchasing power from inflation. For these investors, we can source inflation-linked bonds and inflation-linked bank deposits which grow in line with inflation.

Income Investing

Investors seeking income are primarily interested in generating a higher income. They’re prepared to accept short-term fluctuation in the capital value of their investments, as they usually have a longer time horizon with no requirements to sell. Income-seeking investors may also be interested in trying to maximise their after-tax income and ensuring that their income grows with inflation as their living expenses grow.

However, capital preservation should also be taken into account in selecting the mix of income investments. Less sophisticated investors are often attracted to investments promoting very high rates of interest without fully understanding the risks, including the higher risk of a capital loss.

Some of the best income-generating investments at the moment are corporate and high-yield bonds, and corporate loans.

Other income-generating investments include high-yielding shares and commercial property. Shares which have been popular for their high dividends include banks, telecommunications companies, food retailers, property securities, as well as utilities and infrastructure companies. Many of these companies have stable earnings, which means their dividends tend to be relatively stable and grow with inflation – for example, as food prices, phone and utilities bills increase.

Capital growth investing

For investors with a long-term investment horizon, (such as 10 years or more), who are interested in growing the value of their capital, we’ll generally recommend higher growth investments. These include some share and property types and alternative investments. Generally, such investments don’t provide much income, as any income generated is usually reinvested or used to reduce debt – in turn, increasing the future capital value of the investment.

Within this category, certain types of listed shares can provide strong capital growth over the longer term. For example, smaller companies, technology and biotechnology, emerging markets, companies in cyclical industries (such as resources), and media and airlines can – at different times in the business cycle – be attractive high growth investments.

Certain types of property investment are also attractive as a source of potential long-term capital growth. In many cases, investors borrow to invest in residential property, meaning they have “negative income” from the investment but enjoy magnified capital gains on their property if it rises in value over time.

Finally, commodities and collectibles, such as gold bullion or works of art, can provide long term capital growth potential at certain times.

For further analysis, download the full report.

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