To invest well, you need to find investments that fit your financial goals, investing time frame and
Question:
To invest well, you need to find investments that fit your financial goals, investing time frame and risk tolerance.
Types of investments and returns
Investments can be classified as defensive or growth investments.
Defensive investments
Defensive investments are lower risk investments. They aim to provide income and protect the capital invested. Defensive investments include cash and fixed interest investments. They're typically used to:
- Meet short-term financial goals (up to two years).
- Diversify a portfolio.
Defensive Investment | Characteristics | Risk, return and investing time frame |
Cash | Includes bank accounts, high interest savings accounts and term deposits. Used to protect wealth and diversify a portfolio. | Average return over last 10 years: 3% per year Risk: very low risk of losing money Time frame: short term, 0-3 years |
Fixed interest | Includes government bonds, corporate bonds, debentures and capital notes. Used to earn a steady rate of income and diversify a portfolio. | Average return over last 10 years: 3.5% per year Risk: low risk of losing money Time frame: short term, 1-3 years |
Growth investments
Growth investments are higher risk and offer a higher potential return compared to defensive investments. They aim to give capital growth and some provide income (for example, dividends for shares or rent for property). But, the price of growth investments can be volatile over short periods of time.
Growth investments are typically used to:
- Earn a higher rate of return (but this comes with higher risk).
- Meet longer term financial goals, five years or more.
Growth investments include shares, property and alternative investments.
Growth Investment | Characteristics | Risk, return and investing time frame |
Property |
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Shares |
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Alternative investments |
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(Source: https://moneysmart.gov.au/how-to-invest/choose-your-investments)
Consider the information for two investment portfolios reported in the following table.
| Portfolio 1 | Portfolio 2 |
Cash | 30% | 5% |
Fixed Interest | 50% | 0% |
Property | 15% | 0% |
Shares | 5% | 95% |
Alternatives | 0% | 0% |
| 100% | 100% |
|
|
|
Risk (Standard Deviation) | 5.6% | 8.1% |
(a) Using the return numbers for each asset class that are stated in the article, calculate the expected return for each portfolio.
(b) Calculate the expected coefficient of variation (CV) for each portfolio. Which portfolio has the better risk return properties?
(c) Which portfolio should you probably choose to invest in if you had a one year time horizon? How about if you were investing for ten years? Explain why.
Modern Advanced Accounting in Canada
ISBN: 978-1259087554
7th edition
Authors: Hilton Murray, Herauf Darrell