By David McEwen
Monday 15th July 2002 |
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The reason behind this is that, although shares generally produce higher returns than other assets, their prices can go down as well as up. The older an investor is, the less time he or she can afford to wait for prices to recover if there is a downturn.
However, there are times when investors may not wish to, or need to, adhere to that rule. For example, there are different kinds of shares.
An investor wanting income can choose from a decent number of companies on the Stock Exchange that are financially strong, have sound businesses and pay attractive dividends.
Even more appealing, these dividends are often tax free thanks to imputation credits. Although the price of these shares may go down from time to time, an investor will in most cases continue to receive dividends.
That's not to say investors should sacrifice their safer investments to chase high dividend yields on the share market. Many investors prefer more certainty in their later years and lean towards capital guaranteed, fixed return assets like government stock.
This is to be encouraged, but it is worth deciding how much exposure to these safe-but-low-return assets is appropriate. This is part of the asset allocation process that dictates how a portfolio is structured.
Here is one way of deciding how much money to put away into assets that may be safe but produce low returns.
Do some budgeting and figure out what income you need to maintain your basic living needs. That means covering things like food, power and rates.
Don't include relative luxuries like vehicle running costs, holidays and the like but focus on the minimum required to get by.
That is important because one has to be able to survive no matter how bad times become. We may not have been through a war, inflationary bout or economic upheaval for many years, but that's not to say they won't come again.
Government stock is considered the only truly safe investment in times of trouble. That's because a government has the ability to levy taxes, meaning that it will nearly always be able pay interest on its borrowings.
Therefore, investors should make sure that they have enough invested in ultra-safe government stock and cash equivalents to cover their survival needs.
Money that is surplus to this need can then be invested for higher returns. If things go well, you can spend money on the car, boat or holidays. If it doesn't, you can sleep easy, knowing you have a guaranteed income that covers your basic requirements.
If having all your money in safe, low-yield investments still produces enough income to allow you to live a comfortable life, then sit back and enjoy it.
Most people, even when they are retired and have to live off their assets, need to try and generate as much income as possible without putting their capital at risk.
Chasing higher returns involves more risk but that's no reason to avoid attractive investment opportunities. The key is in structuring your portfolio so that the ultimate risk, losing your valuable capital, is as low as possible.
David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.
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