Life Advice

Parent category

I have created the below cheat sheet to get an idea of the risk profile of investments. These are not ALL investment types, but the ones I want to discuss.

Cash
This is essentially 0 risk. Hold your cash (emergency funds + funds not ready to be invested or holding for other opportunities)

Property
Can be a good way of earning capital growth (Capital growth is an increase in the value of an asset or investment) Through appreciation of house prices or income through rent (or both!). However the initial investment for one of these warlocks these days is so high (in Sydney anyway) that we’ll tackle this in another post. These kinds of investments could help you build and make that deposit, so read on!

Types of Shares – Ordinary Shares, ETFs & Penny Stocks
Yes, they are all the same things but slightly different. In terms of variety of risk, shares have the largest spread. They can range from low to high, it all depends on the company you chose to invest in. Before we go into this, let’s understand ETFs.

  • Ordinary Shares – this is a SHARE in a company. So if the company does well, so will you (in theory).
  • ETF – An exchange traded fund (ETF) is a basket (or bunch) of securities that trade on an exchange, just like a share, so when you own a share of an ETF, you will own a little bit of all shares in the ETF.
  • Penny Stocks – A penny stock typically refers to the stock of a small company that trades for less than $1 per share and hence the name penny stock. They seem very cheap and you can usually buy a lotttt of shares and then small changes in the price of the shares can make you very rich or poor.

How do you differentiate between high and low risk?
Think – Risk types. A good detailed document can be found here. But I think they are quite easy to understand with some common sense.

  • Volatility risk: how big the swings in price can be. I.e penny stocks and mining / exploration shares can have very high fluctuations. If good news comes in boom, if not, bust.
  • Timing Risk: Think COVID. Airlines are struggling right now so the share price is probably low (or is this an opportunity?).
  • Legislative Risk: i.e Cannabis could be announced as legal
  • Currency and Foreign Exchange Risk: Many companies operate world wide. If they have significant operations in Japan and an earthquake happens – potential busto.
  • Sector or Market Risk: Technology / mining / Travel / Gold could boom. Which market is your share in?

Generally, with higher risk comes higher (potential) return
I think that’s enough said here.

  • Barriers to Entry & Effort
    Barriers to Entry here is essentially how much money you need to get started in this space. At least with CBA the minimum is $500 to purchase a parcel of shares. Whereas a house is roughly going to set you back 10% of the purchase price. (Kel’s friends recently purchased a $2m house, so that’s at least $200,000 just to get started!). It may also be hard to set up trading accounts, although it’s very simple see my – Shares Part 1 – Setting Up A Share Trading Account.
  • Effort: How much time do you want to spend monitoring and investigating your investments? With MOST ETFs, you can generally just sit back and trust that someone smart is doing the hard work for you (that’s why they take the management fee). Otherwise you might find it fun to research penny stocks and play ‘Where’s the Gold’ and get some Lucky 88!

Crypto Currency
Who even knows with this stuff – it’s literally gambling so if you want to spice it up a bit – I suggest Compound – for no reason other than I saw it somewhere in my crappy newsfeed.

Next in the series we’ll look into:

Create A Trading Account


Step 1: Go to Commsec and click ‘Join Now’

Step 2: Click ‘Open an Account’ and go through the prompts

Step 3: Open a CDIA (or trade with your bank – not recommended). You will need your your ID – See details below.

Step 4: Confirm details via email

Step 5: You’re ready to trade – however you’ll need to put some money in your trading account (CDIA).

So I have an account, now what?

I would recommend reading my next blog – which I haven’t written yet. Also familiarise yourself with my previous post – Beginners Guide to Investing (Shares, Crypto and Trading Cards and more) and How much money should I be investing?

Other Details

Caveat 1, each bank is slightly different, but generally the same. I use Australia’s largest retail bank – Commonwealth Bank of Australia, therefore will use Commsec as their trading platform.

Full disclosure, I am not advertising or sponsored by CBA.

We know how much to invest from the previous post: Investing Fundamentals: How Much Do I Invest?

The next concept we want to think about is where we should be placing our money and this allocation will be based on the risk of the investments. 

You might be familiar with the concept of risk-reward, which states that the higher the risk of a particular investment, the higher the possible return. This will help us to apply some sort of logic to our own circumstances and give some guidance around allocating our funds based on risk and return.

Each investment will have a different risk profile and some more risky than other. Example, a small exploration mining company without any certainty on finding something will have a higher risk than a large established ‘safe’ company like CBA.

From here on I’m NOT going to consider Cash sitting in the bank as an investment – that is part of your Emergency Fund established in the previous Post. Here on, investments are anything other than bank deposits.

Investment Pyramid

Each person will have different risk profiles depending on their situations and life experiences. Use the Quiz below to get a feeling of your risk profile and how you can start looking at structuring your investment portfolio:

Risk Profile Quiz

Example Portfolio Allocation based on Risk

Now that we have a better understanding of what OUR Risk Profile is, let’s look at what kind of assets we should start investing in based on this profile. See the next Post in the series: Investing Fundamentals: Investments Based On Risk Profile

Possibly the most difficult question to answer in getting started in some serious investing. This is not a perfect guide as each person is different, this is MY APPROACH which you can feel free to follow or take parts of to apply them to your circumstances.

Questions to ask yourself

How much cash do you need to last an ‘Emergency Period’ of X Months?
X month is different for each person. I would interpret it as how long it could take until I start earning decent money again? For me this might be 2 months, for others it could be 6 months to a year, it depends on jobs, specialisation, business type, market, etc.

To determine this we’ll have to set up a simple
Personal Income Statement:

The main parts to this are:
 – Income: for most people this will be on your payslip  / salary
 – Expenses: from your cash / credit card / debit spends

How much money do we need to live (on current spending patterns)?
It’s a good idea to log into your bank and some have features which will tell you how much you spend. Example Macquarie Bank

It’s best to find a base for your spending, either monthly or yearly. Then you can understand for yourself more easily. Just note that sometimes the spend can be skewed by a holiday or other expenses, so you can normalise these for a more accurate number. I.e I might only go on 1 holiday per year, so $14K would be much too high.

So… what’s my minimum? $2,900 per month. Yearly…. $35,100

Final Result: $2,900 per month. For 6 months I’ll Need $17,600
This money will be kept in cash (in a bank account) and (hope to) never touch unless you really need to.

How much cash do I have available to invest?
Take some time to form a to look at your cash balances and other assets.  This will help determine how much money we have left over to potentially invest (As we need a buffer of $17,600 minimum).

Cool – maximum investment amount $62K, but

What would be a reasonable amount considering my circumstances?
Considering this further, we may want to bulk up our emergency fund to consider the following:

  • Age / Closeness to retirement: The older you are the more you want to bulk up your fund with protected cash
  • Dependents / Inheritance: You may have children on the way or want to pass on a lot of your wealth to kids / grandkids.
  • Future Earnings Ability: you might have a successful job and be earning significant cash each year so your current balance feels particularly low
  • Other Expenses
    • Funding your retirement – ensure your super balance is adequate to fund your desired retirement lifestyle
    • Upcoming significant expenses – holidays, purchasing a house, wedding etc

Examples

The below examples are simple examples not financial advice. Apply your own circumstances and knowledge to your situation before investing. 

Simply put these examples will give you an idea of the maximum amount of money you could invest. The weighting is your personal subjective opinion on each of the 4 categories. You can find the template HERE to manipulate your own google sheet and set yourself up to invest! The additional steps below will add  to your starting emergency funds to provide additional safety to your equity.

Example A: Young Person in a solid Financial Position

  • Age / Closeness to retirement: 30 Years old, 20+ years to retirement. Long way off, would be wanting to build adequate retirement funds
  • Dependents / Inheritance: No children expected in the next few years and no dependants.
  • Future Earnings Ability: Currently earning in excess of $100K yearly with regular pay rises and promotions expected over the medium-long term.
  • Other Expenses
    • Funding your retirement – Want to enjoy a comfortable retirement, nothing too flash
    • Upcoming significant expenses – Wedding planned in the next year, expected to be $20K

Example B: Closing in on retirement

  • Age / Closeness to retirement: 55 Years old, <5 years to retirement. Very close to retirement, should be protecting assets built up over the years to spend during non-working times.
  • Dependents / Inheritance: 10 kids & grandchildren, they are self sufficient but want to ensure they are provided for comfortably before and in the Will.
  • Future Earnings Ability: Currently semi-retired and spending the majority of this money for life expenses and enjoyment. Earnings will only deteriorate from here.
  • Other Expenses
    • Funding your retirement – Want to enjoy a comfortable retirement, nothing too flash
    • Upcoming significant expenses – None to note.

Example C: Young and supported by family – e.g Uni Student

  • Age / Closeness to retirement: 20 Years old, +35 years to retirement. Very far from retirement. Longest time to build asset value.
  • Dependents / Inheritance: Nothing planned for now or in the future.
  • Future Earnings Ability: Might make some cash mowing lawns or very part-time job, but earnings can only go up from here. Parents will be supporting most expenses.
  • Other Expenses
    • Funding your retirement – Want to enjoy a comfortable retirement, nothing too flash
    • Upcoming significant expenses – Holiday for a gap year or something. Important for life experiences.

Summary

Each person is in a different circumstance. Looking at your life factors will help determine how much you can afford to invest. 

You want to have a good balance between using your assets effectively to further your income and protecting the equity you’ve earned over your lifetime. Every year or so you should consider if your life circumstances have changed and adjust accordingly.