Saving and investing are about your goals. Maybe you’re dreaming of a new car, getting your foot on the property ladder, or taking an overseas holiday.
Whatever it is, you’ll need money to achieve it. It’s important to have a solid understanding of investing and what can positively and negatively influence those investments.
This article explores the definitions of an investment and the four factors that affect how much your money grows.
What is an investment?
An investment is an asset or item you purchase to generate income or increase in value over time. Assets can vary.
- Shares
When you buy shares, you expect to receive a regular dividend and that they will be worth more when you sell them. - Property
When you buy a property, you expect to receive rental income and some capital gain when you sell it. - Term Deposit
When you put money into a Term Deposit, you park money away for a set time to receive a set return.
Which one best suits you depends on your investing goals and your time frame.
There are generally three standard time frames. They are the length of time you need to wait before you receive some form of return, whether that be income, dividends, or an increase in the asset’s value.
- Short-term (0-2 years)
- Medium-term (2-5 years)
- Long-term (5+ years)
Four factors that affect investments
1. The economy
The national and international economy has four cycles, each playing a major part in investment returns.
This is why long-term investments like Superannuation are designed to be left in the market long enough to ride out the ups and downs to achieve a reasonable long-term return.
2. Compounding interest
Often described as the seventh wonder of the world. Compound interest is the interest you get on the money you initially deposited, called the principal, and the interest you’ve already earned. In other words, you get interest on your interest. The power of compounding helps you to save more money. The longer you save, the more interest you earn.
Example
Natasha received an inheritance when she was 20, so she invested $50,000 into a savings account. She met and married Will in her 30s, and now they are both in their 50s and planning for retirement.
Going through their finances, Natasha told Will about the $50,000 she had invested when she was younger. Will was pleased but said he could match that as he had also invested $50,000. The difference was that Will made his investment when he was 40.
As you can see, the more you earn compound interest, the better because you are reinvesting the profits of your investment repeatedly.
3.Taxation
When deciding how and where to invest, you need to consider the different types of taxes you may need to pay on your investments.
Tax is a complex area, so you might want to get some professional advice.
These are the most common taxes that can affect your investments.
- Income tax
Income tax is what you pay on wages and any other income you receive, including interest and dividends.
- Capital gains tax
A capital gain is the difference between what an asset costs you to buy and what you sell it for. The capital gain (or profit) gets added to your income and is taxed at those rates. When you sell the home you live in, no tax is applied to any capital gain.
- Superannuation tax
When you contribute to superannuation, up to $27,500 each year is taxed at 15%*. This is generally much lower than income tax rates. If your savings goal is retirement, superannuation can be a good strategy.
- Other taxes
When you purchase investments, you may need to pay other taxes, such as stamp duty and GST.
4. Inflation
Inflation is the increase in the cost of goods and services over time. Here’s a straightforward way to explain it.
In 1985, $100 would have bought about 100 loaves of bread. If you had put that $100 under a mattress and used it today, it would only buy about 40 loaves of bread. If you wanted to buy 100 loaves of bread today, the $100 would need to have grown to $250 just to retain its original buying power.
Knowing the four factors that affect your investments can help you make more informed decisions about saving to achieve your financial goals.
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