Investment Fundamentals: Investment options to reduce the risk

By Liz Maroney, Westlawn Wealth Adviser
11 September 2013

In Know your asset classes in our August edition of Westlawn Monthly News, we explained how investments are grouped into different asset classes according to the type of investment and its relationship to risk and return. That article also stressed the importance of diversifying investments across different assets and asset classes to reduce investment risk.

If you missed it last month, you can read the article here.

Here, we look at some of the investment options available that allow you to easily diversify your investments in order to spread your investment risk and reduce volatility over the medium to longer term.

Managed funds

Managed funds would be familiar to many investors. They are pooled investments managed by professional investment managers on behalf of investors. Investors purchase units in the fund at a certain unit price. Unit prices are generally calculated daily, and will rise or fall depending on the performance of the underlying assets held within the fund. When the investor wishes to cash in their investment, they sell at the unit price current at the time of redemption.

Over time, investors may receive capital gains if the unit price rises. If the unit price falls, however, investors may be subject to a capital loss. Investors may also receive regular distributions depending on the individual managed fund and the assets held within it.

The performance of any particular managed fund will depend on a range of factors such as the fund’s allocation of assets, rises and falls in the sharemarket, changing economic conditions, currency exchange rates (where international shares are held) and the expertise of the fund’s investment manager.

Potential benefits of investing in a managed fund can include the ability to spread investments across different assets and asset classes such as Australian and international shares, property, fixed interest and cash. Managed funds also offer simplified tax reporting (when compared with holding shares individually), the option to make additional regular contributions and professional management of the investments.

Managed funds may, however, incur higher management fees than some other investment options offering similar diversification.

Exchange traded funds

Exchange traded funds (or ETFs) also offer the ability to diversify investments, and are generally regarded as a lower cost alternative to managed funds. Rather than buying units in a fund, with an ETF, you purchase shares in the fund through your stockbroker or online trading account in the same way you’d purchase company shares listed on the stock exchange. Fees on an ETF are calculated through the buy/sell spread. At any one time, the “buy price” of the fund will be higher than the “sell price”. This difference is the “buy/sell spread”.

ETFs are regarded as passive investments that track a particular type of asset or market index such as the ASX 200. This contrasts with managed funds which are actively managed with the investment manager making decisions on when to buy and sell individual assets within the fund.

For an ETF tracking the ASX 200, for example, the fund will spread its investments across the companies making up the ASX 200. Rather than attempt to outperform the ASX 200, the ETF will aim to achieve similar performance over time.

ETFs are available for a wide variety of assets such as Australian and international shares, fixed interest and foreign currencies. There are even ETFs that track precious metals and commodities markets.

Listed investment companies

Like ETFs, listed investment companies (LICs) are bought and sold on the sharemarket, and similarly offer exposure across a wide range of investments from Australian and international shares through to private equity and specialist sectors such as resources, technology and telecommunications.

Unlike ETFs however, which are considered passive investments, the investment style of any particular LIC will vary. Some may have a conservative approach to investing assets while others may be more aggressive.

Many LICs manage their investment portfolio to minimise tax and to pay investors a regular income through fully franked dividends. Of course, as is the case with any ASX-listed shares, dividends are paid at the company’s discretion.

The value of an LIC’s underlying investment portfolio on a per share basis is referred to as its Net Tangible Assets (NTA). The on-market price quoted for an LIC will relate to its NTA. However, like shares in any company, the price will be determined by supply and demand. So, an LIC may trade at a premium, a discount, or on par with its NTA.

Know your investment goals

As with any investment decision, you should have clear investment goals, understand the level of risk you’re prepared to take and determine your time frame for investing before investing in any managed fund, ETF or LIC. You should also seek professional advice.

As a Westlawn Wealth Adviser, I’m qualified to provide advice on managed funds, ETFs and LICs as well as other investments.

Copyright © 2013

General Advice Warning
The advice on this site may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial, tax and/or legal advice prior to acting on this information.

Westlawn Wealth Management Pty Ltd ABN 32 124 861 409, Authorised Representatives of GWM Adviser Services Limited ABN 96 002 071 749, Australian Financial Services Licensee, 105 -153 Miller Street North Sydney NSW 2060.

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