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The Fierce Girl's Guide to Finance

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diversification

3 Key Investment Concepts explained by The Spice Girls

It’s Sunday morning, I still have glitter all over my face from last night’s Oxford St make-up, and I’m drinking coffee in bed. The only thing that could make today better is dropping some knowledge bombs on you all.

If you didn’t hear about the Great Disappointment of 2019, last week Mel B told us that The Spice Girls were coming to Australia, before clarifying that actually it was just a vague intention.

Anyway, since this Girl Power phenomenon was a huge formative influence on my life, I decided to give them their own Fierce Girl post. And sneak in some learning at the same time.

So, here I give you three important investment concepts they should really teach at school but usually don’t.

Capital Growth – this is when an investment or asset increases in value over time, without you having to do anything.

Capital Growth is the Spice Girls of the investment world. For that brief moment of joy where we thought the band was touring Australia, my friends and I considered how much we’d pay for tickets. ($1000 was too much, $999 we agreed was ok). Those girls haven’t made an album in decades but they get more valuable over time!

With assets, homes are the most common example of a capital growth play. We buy them and hope they’ll double in value every seven years and in a rising market, that does happen. But all markets follow a cycle, so if you buy at the wrong time, you may either miss out on capital growth, or see it go backwards. (Read this post for more info).

When people buy shares, they are often looking for capital growth, especially if it’s an up-and-coming company that doesn’t make a profit. You don’t get any dividends in this case, but hopefully in a few years those $1 shares are worth $5. I already wrote a whole post about how buying shares is like choosing husbands (here). But when I think about it, it’s kind of like creating a girl band. They could end up as the Spice Girls, or they could go the way of Bardot (sorry Sophie Monk).

Ouch, my nostalgia-o-meter just kicked into overdrive and I feel old AF

Yield – Income – Dividends

These are all basically the same thing, and refer to the cashola you earn from owning an asset. Also known as passive income.

Do you ever wonder how Sporty Spice seems to live an A-list lifestyle, even though we haven’t heard much from her since the 1999 dancefloor banger ‘I Turn to You‘?

Yep, that’s right, she’s living off royalties. Apparently all five girls have co-writer credits for their songs and get paid when people play or perform them.

This is the kind of passive income I want in my life, but since I have zero musical talent, and am probably past my prime girl-band age, I’ll have to buy some blue-chip shares instead.

Retirees are big on ‘yield stocks’ like Telstra and the Big Four banks, because they need  income to live on day-to-day.

For myself, as a young investor, I’d rather re-invest that income to grow my nest egg, and in fact many companies have an option for doing this. It’s called a Dividend Reinvestment Plan (I know, they could have catchier name). Say you have $1000 worth of Telstra shares and they pay a 7% dividend, instead of taking that $70 and putting it in the bank, they just give you $70 worth of their shares. It all happens automatically once you sign up for it, and you don’t need to pay a broker (which is normally the case for buying shares).

It’s as easy as letting Spotify create a Pop Queens playlist for you. (Athough, tbh, I’ve made my own and it’s great. You’re welcome).

When it comes to property, rent is the key income stream. If you have an investment property where the rental income is enough to cover the costs of the mortgage, strata and other bills, it means it’s positively geared. (‘Gearing’ refers to debt, so it basically means the income is greater than the cost of servicing the debt).

If the rent isn’t enough to cover the costs of owning the property,  you have to put your hand in your pocket to top it up. This means it’s negatively geared – as you’re making a loss on an investment.

If you’re thinking ‘wait, what, why would anyone want to make a loss on an investment?’ then you have obviously never experience my dating life, which is all about putting in more than I get out. (Although I’m down with that now).

The key insight here is that investment losses are tax deductible. So, say you have to cover $10,000 a year of investment property costs each year, you can reduce your taxable income by that amount. i.e. maybe get a sweet little tax refund.

Like, I see how this is good for people who hate paying tax to the government (ok, literally everyone). But I personally don’t relish the idea of finding extra money all the time, which is one of many reasons I don’t have an investment property. But if you do, that’s great and no judgement – you do you, boo!

I just think people get excited about negative gearing but forget they are still making a loss, AND the strategy relies on the property increasing in value (capital growth) to make it work. Which is not happening much at this point of the cycle, and also is dependent on where and what you buy.

Anyway, this isn’t meant to be a rant about Australians’ obsession with property, but a rant about how important the Spice Girls have been to our lives (if only I had a photo of my platform sneakers from 1997.) So let me get to the next point…

Diversification 

Of course there are more investments you can make than just shares or residential property. There are bonds, REITs, commodities, infrastructure etc. A sensible portfolio will have diversification, and that is exactly where the Spice Girls have excelled.

Each member is unique and brings something different. Well, I think Posh’s contribution is minimal, but someone may want to fight me over that comment.

When we were young women looking at the fab five, we could all identify with something, whether it was their hair colour, fashion sense or personality. Having a bit of everything helped to make a great band.

Finance is the same. If you just put all your money into property, then you might be missing out on the returns of shares, for example. These asset classes are often ‘uncorrelated’, which just means they do their own thing: while property is falling, the sharemarket could be soaring – which is happening right now. So if you have a bit of each, you spread the risk. When Ginger Spice was in a bad place of eating disorders, yoga videos and questionable solo songs, Posh was marrying Becks. Markets and people all move in their own cycles.

Wow, this was quite a long post so if you’ve stuck with it, well done. Your prize is a night on the Spice Girls red bus, which is now an Air BnB. Enjoy!

Sleep well surrounded by 90s nostalgia, Fierce Girls!

An Insider’s Guide to Finance: the risk-reward relationship

I’ve taken plenty of risks in my life. Some were productive, like packing up and moving to London. Leaving my marriage was a big risk that was hard to take, but the right thing to do. Wearing neon patterned tights with a crushed velvet skirt to a mufti day in year 7 – that risk did NOT pay off in either social or fashion terms.

When it comes to money, you need to get comfortable with risk. You see, there is a thing called the risk-reward premium, which means the higher the risk, the higher the (potential) reward.

This also means you can put a price on risk – the riskier the deal, the higher the stakes.

It’s why a car loan has a much lower interest rate than a credit card. The car can be repossessed if you can’t pay back the loan, while the credit card is ‘unsecured’ – they can’t come after you for the delicious cocktails you just bought, and the bank manager won’t fit into that Kookai dress. So the risk is higher for bank and more expensive for you.

Risky Business?

Now I am not saying let’s go to Vegas and put it all on black.

But when you invest, you want to balance the risk within your portfolio and within the asset class so that you get a good return while not losing your money.

Ok wait, I just dropped some jargon there. Let’s break it down.

Your portfolio is your entire wardrobe.

Your asset classes are each section: shoes, dresses, underwear, activewear, etc.

We talk about being ‘underweight’ or ‘overweight’ certain types of investments. For example, when the banks aren’t performing well, you might sell off some of those stocks and become underweight in banks. Or if you think resources are about to get hot again, you buy more and go overweight.

This can apply within one asset class – so you can be overweight on running shoes and underweight on high heels, within the broad ‘footwear’ asset class.

Or it can apply to the broader asset classes, so you have heaps of activewear, but not much in the way of work clothes (yep, me). That would be like having a lot of property (your own home) but only a small parcel of shares.

So now we have the lingo, let’s talk about risk. Here’s what you need to know:

1. You need some risk in order to make money, and that’s ok.

2. You can manage that risk by spreading it around – aka diversification

Now let’s talk more about that.

Why risk is ok.

Risk is what makes you money. It’s the old adage of ‘nothing ventured, nothing gained’. So it’s safe to keep your money in a term deposit in bank, but that’s not going to make you money.

In fact you could even lose money in the bank.

Wait, what?

Thing is, there are heaps of different risks when it comes to money, and one of them is inflation risk. You know how a bag of lollies used to cost 20 cents when you were a kid, and it’s $2 now? That’s inflation.

The value of money changes over time (it’s a really complicated backstory as to why), but let’s just say, inflation usually runs around 2-3% per year. (It’s lower than that right now, but has often been 5-6% in the past 30 years).

If your money is in the bank getting 2% interest, and inflation is 2%, you aren’t making money, but you’re breaking even. But if inflation goes up to 2.5%, you’re actually losing money. The dollar you put in buys less than what it bought a year ago.

This makes intuitive sense right? Things cost more all the time.

So that’s called Inflation Risk, and it’s a risk you face even when you think you’re not facing a risk. Crazy huh.

Here are some other fun and friendly risks:

Interest Rate Risk – The risk that interest rates will change and affect your investment. For example, you buy a property at 5% interest from the bank and then interest rates go up. Suddenly, the $2000 a month mortgage that was covered by rent becomes $2200. Not only do you have to find more cash, it changes the yield – i.e. the return you’re getting for the money you spend.

Liquidity Risk – The risk that you might not be able to turn your investment into cash as quickly as you need to. In the example above, you decide to sell the house as you can’t cover the repayments. But a bunch of other people have been hit by rate rises and are selling too. And with home loans more expensive, the number of buyers falls. So you might have the house on the market for several months, even drop the price. The property investment has low ‘liquidity’ and it can cause all sorts of headaches.

Market Risk – You can be the best stock picker in the world – or pay the best stock picker – but if the whole market falls, it’s pretty likely your investments will fall too. Economies – and the markets they’re part of – are always cyclical. They go up and down – that’s as much a part of life as the fact that you’ll get your period on the exact day you don’t want it to come.  The trick is to be prepared for the cycle and have diversified your risks – that way you can manage the dips when they come.

This is just a short list to give you a flavour. There are plenty more, like

  • sequencing risk (the risk that your investments are in the toilet right at the time you need them);
  • credit risk (the risk that the company you lent money to – in the form of bonds – goes under and doesn’t pay you back);
  • operational risk (the risk that you invested in a company run by morons who bugger it up and lose your money); and
  • concentration risk (the risk that you put all your eggs in one investment basket and then drop the whole darn basket).

You can make friends with risk

I’m not trying to scare you though. You don’t avoid investing just because there are some risks. If I listened to my mum about all the risks of going on holidays to the US (being shot, getting raped, the plane crashing, the car crashing…) then I’d never go.

What you do is manage risk, by being clear about your time horizons and your goals. (A financial adviser can totally help you there).

The rule of thumb is that you only invest in shares if you have at least a five-year horizon, because that’s how long you need to smooth out their ups and down (technically called volatility).

An investment property generally needs even longer because of the costs and drama associated with buying and selling.

And with your superannuation, you have 30-40 years to smooth out the returns, so if you’re young (under 45 or so) then you can tolerate even more risk in the hope of getting higher returns.

Spreading the risk is crucial. The ideal (possibly over your lifetime) is to have a bit of everything. Not just a property, not just shares, not just a term deposit, not just bonds. A bit of everything.

But you can start small. For example, think about a managed fund or ETF if you already own your home. Think about buying listed property instruments (REITS) if you already have shares but can’t afford an investment property.

Basically, don’t just buy a bunch of super cute high heels but then never have any good flats you can walk in.

Risk in a nutshell

So here are the takeaways you should know about risk:

Risk is a part of life, and investing. But if you stay away from crazy, get-rich-quick, too-good-to-be-true investments, you can tolerate and manage risk effectively.

There is also risk in doing nothing. Letting your money sit there and track inflation is a risk, because you risk your future returns and wealth.

So don’t be scared of risk – because the other side of it is reward. Imagine if you never took the risk of drinking too much, wearing too little and partying too hard – what fun stories would you have to remember? Investing is just like that, but with less booze.

Photo credit: Aaron Perkins

 

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