Jonathan Cattana: Which asset class should I invest in and why?
Step 1 of our game plan to pay for private school fees is to determine the best asset class to invest in based on your circumstances and goals. This is step one in the two-step game plan that will help you bring the overall strategy together when we work through the next chapter.
You could well ask ‘just tell me straight off, what asset class and how do I use this asset to get to my end goal?’ But before making any investment decisions, it is always prudent to ask yourself: What am I investing in? What is the asset, and what returns can I reasonably expect? Therefore it is important to ensure you understand a bit more about what we are investing ‘in’.
First, let’s look how the asset class of cash performs.
Cash
Of all the asset classes this is the worst performing in terms of investment growth. There is virtually no growth with cash investments. Savings accounts offer minimal or no interest and any interest they do offer is outweighed by account fees. As we all know, cash is easily accessible, accepted everywhere and useful for purchasing goods, paying for services and to survive day-to-day.
However, as a saving vehicle, cash does not generate enough growth to provide future income for goals such as funding private school fees. In the Australian banking system, there is an excess of cash just sitting in the banks and cash management trust, most of them earning very little interest. If you leave your savings in cash, you better watch out for inflation.
For example, if you left $10,000 in cash in a bank account in 1995, inflation over the period 1995 to 2006 would have eroded your purchasing power to $7,831. (That’s a loss of 21.7%. So, unless you earn more than inflation, your wealth is essentially going backwards. You need to invest your cash that is not earmarked for short-term goals into other asset classes.
Fixed interest
Some fixed interest investments will produce a steady, regular income return, but their main problem, like cash investments, is limited growth. A fixed interest fund manager will invest your money into an array of corporate infrastructure projects, government bonds and bank bills. Other examples of fixed interest include structures like convertible notes and floating rate notes.
I recall many discussions with investors telling me that investing in fixed interest is safe and they can’t lose money. This is not always correct. Ask those investors who looked for the high interest rate returns from investing with Pyramid Building Society, Victoria’s largest building society and Australia’s second largest, in the late 1980s and early 1990s, their investments are gone.10 Ask those who may have been holding corporate bonds from previous entrepreneurs whose company may not be able to pay their coupon interest and therefore defaulted on their obligations.
I am highlighting these examples to prove that you can lose your capital on fixed interest investments. Investors also misunderstand the higher yield catch. A higher yield means higher risk. If it’s too good to be true, it probably is. For example, a debenture paying a high yield of 11% is being invested in riskier property building projects than the banks may want to be involved with. Some debenture companies take on this riskier project and therefore are required to pay out a higher yield in order to attract investors.
For our purposes, however I don’t recommend investing your cash in fixed interest investments. The previous generation preferred fixed interest investments because they could depend on the regular monthly income, and they were happy with that. As our goal is to find an asset that will generate enough income to pay for our yearly private school fees bill, we need assets that produce a stable and growing income together with some growth to protect our capital base.
If we need our original capital base (our initial investment) to grow, we need to invest in growth assets. When we want our investment to go from $10,000 to $50,000 over a number of years, it requires a growth factor to get us there. The growth component of our return moves the value of our portfolio upwards in value.
Now I’ll show you some growth assets.
