7 investments to earn better than bank interest from the stockmarket.

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1 7 investments to earn better than bank interest from the stockmarket.

2 If low tide on interest rates has left you looking for better returns, the stockmarket may be an alternative. Sentinel Stockbroking is pleased to provide this introductory guide to earning income from the stockmarket.

3 Stockmarket Overview INTRODUCTION With interest rates falling to record levels, many people are looking for alternatives to earn better returns on their savings. The stockmarket is potentially a solution but can be a daunting prospect when starting out. This introductory guide is designed to help investors better understand the stockmarket and some of the investment alternatives available. RISK VERSUS REWARD Assessing whether the stockmarket may be right for you begins with an understanding of the concept of risk versus reward. In an investment context, risk is the likelihood of losing your money, while reward is the amount you can earn. Every investment has a risk-reward payoff that is, how much risk is involved to achieve an expected level of return. Broadly speaking, the higher the risk, the higher the reward and vice versa. So when assessing what is right for you, it is largely a process of working out which riskreward payoff suits your preferences. The risk-reward payoff of investing in a bank account is such that you have very low risk of losing your money but on the flip side, you also earn very little in interest. Whereas investing in the stockmarket, the payoff generally involves higher risk for a likely higher return. In a practical sense, this is the important distinction to make when considering whether to move money out of the bank and into the stockmarket. Investing in the stockmarket involves a risk that you could lose some or all of your money, or that your earnings may be less than expected. However in compensation for this higher risk, you also expect to earn a better return. DIVERSIFICATION AND PORTFOLIOS It is important to note that stockmarket risk comes in various levels and can be controlled and managed by various techniques. By investing in a range of different investments, you can spread the risk and avoid having all your eggs in one basket this is known as diversification. This is where the assistance of a qualified stockbroker is so important because they can help build portfolios to reduce the risk and maximise your return potential. Pg. 3

4 Other Stockmarket Considerations There are many differences between putting your money in a bank account and investing in the stockmarket. Some considerations to be aware of include: Payment of returns - interest on bank deposits is often paid in fixed frequent intervals (for example, monthly, quarterly, etc) whereas stockmarket returns are typically paid bi-annually. Variability of returns - interest on bank deposits is usually fixed and known with relative certainty in advance whereas stockmarket returns can be more volatile and change over time. MORE INFORMATION The Australian Securities Exchange (ASX) provides detailed information regarding many aspects of stockmarket investment - a good starting point is their website at Financial Markets are regulated by the Australian Securities & Investments Commission (ASIC) and their website at may also assist. Finally, Sentinel s website at provides a range of information on the stockmarket and stockbroking services. CONCLUSION Investing in the stockmarket entails more risk than leaving your money in the bank but the expected rewards are greater. If managed correctly, the stockmarket is most definitely an investment worth considering. Explained on the following pages are some of the different types of stockmarket investments which could be considered: Liquidity - bank deposits can be withdrawn almost immediately whereas stockmarket investments must be sold and generally take three business days to become available. Transaction Costs - there are normally no costs associated with moving cash from one place to another but stockmarket investments must be bought and sold which can incur transaction costs known as brokerage. This list is not exhaustive and again, professional advice is invaluable in understanding and considering the stockmarket. Pg. 4

5 the technical stockmarket term for this is a dividend. This is how you earn income from the stockmarket by sharing in the underlying returns of the company you own paid out as dividends. Franking Credits When companies make profits, they generally have to pay tax like everyone else. So when companies distribute their after-tax profits to shareholders as dividends, they also distribute a tax credit for the tax they ve already paid - this stops the profits of the share effectively being taxed twice. These franking credits (technically known as dividend imputation credits ) can be a very powerful way for investors to earn tax effective returns (especially in self-managed super funds for example). However, understanding franking credits can be quite technical and you should seek the help of your accountant or financial adviser when reviewing this area of the stockmarket. 7 Stockmarket Investments That Can Earn Income 1. SHARES As the name suggests, investing in shares means you are literally buying a share of a something. This may include a share of a company or business, rights to an earnings stream, or much more. People often don t appreciate that when they buy a share in the stockmarket, they are in fact becoming an owner of that company and its underlying businesses. As a part owner of the company, you are entitled to a share of any profits or returns it distributes. When a share pays out a return, 2. LISTED PROPERTY TRUSTS (LPT S) If property is of interest, the stockmarket offers an effective way to invest with a range of advantages over direct property ownership. Listed Property Trusts are essentially pooled investments where a number of investors combine their funds to buy property assets. Through the stockmarket, investors can then buy units (small, standardised portions much like shares) in the Listed Property Trust and enjoy their share of the income streams and benefits that flow from the property assets. One advantage is that the units on the market are much smaller and cheaper than buying an entire property (because you re only buying part of the property rather than the whole lot). This means you can invest with smaller amounts of money. It also means that you can spread your property exposure over a range of properties rather than just having one lumpy asset (this is known as diversification ). The other major advantage flowing from the stockmarket is that you can quickly buy or sell holdings in Listed Property Trusts whenever you like (this is known as liquidity ), whereas selling real property often takes a lot of time and can be workload intensive. Pg. 5

6 7 Stockmarket Investments That Can Earn Income 2. LISTED PROPERTY TRUSTS (LPT S) (CONT.) Listed Property Trusts enable you to enjoy the income streams that properties produce (like rent) without having to commit to the workload and inflexibility of owning a direct property. This makes them a worthy consideration as an alternative to investing in bank deposits. 3. HYBRID SECURITIES (ALSO KNOWN AS INCOME SECURITIES) As the name suggests, hybrid securities are investments made up of a mix of both shares and debt (interest generating loans). The makeup of this combination varies from one hybrid to the other so each has a different risk-reward payoff. However the common theme for prospective investors is that hybrid securities typically provide an interest-like return which usually exceeds bank interest. 4. EXCHANGE TRADED FUNDS (ETFS) Exchange Traded Funds (or ETF s as they are commonly known) are investments which combine a group of different shares or assets into a single stockmarketlisted vehicle. So in effect, by buying an EFT, you are in fact gaining exposure to a basket of other investments. This makes ETFs a convenient way to access a wide range of investments for very little effort. ETFs tend to hold the components of a particular market feature such as an index (for example, the ASX Top 200) or a sector of an index (for example the banking and finance sector). One ETF category which may be attractive to those seeking returns above bank interest is High Yield ETFs. These typically hold a collection of higher yielding shares meaning you gain exposure and diversification to many stocks without needing the skills and knowledge to pick and choose them yourself. ETFs are a low cost and a low management workload way of gaining a broad spectrum of investment exposure to suit your preferences. Returns can be fixed at a set rate or floating meaning they will rise or fall according to prevailing benchmark rate (for example, the RBA interest rate). The timing of payments also varies depending on the hybrid and for example can be annually, bi-annually, quarterly or even monthly. The risk of a hybrid depends on many factors but the main factor is the issuer of the hybrid. As part of a hybrid is debt, you as the investor are effectively lending your money to the company issuing the security. Therefore the strength and capacity of that company to pay the promised returns is paramount. Fortunately, most hybrids in Australia are only issued by the largest companies. However to ensure you re getting the investment that is right for you, it is worth seeking the advice of stockmarket experts familiar with hybrids. Pg. 6 Pg. 6 Sentinel Group - Guide To Options Trading

7 Managed funds offer a very diverse range of investment choices including the types of products invested in, how actively traded they are and what their objectives are. There is likely to be a managed fund to suit the needs of most investors, including many which focus on generating income. Until recently, managed funds have typically been unlisted (that is not traded on the stockmarket) which made them less flexible and easy to access. However the stock exchange recently listed many managed funds on the market making them much easier to buy, sell and hold. For investors looking for a return better than bank interest, there are many managed funds available for consideration. 6. ASX-LISTED BONDS 7 Stockmarket Investments That Can Earn Income 5. ASX-LISTED MANAGED FUNDS As the name suggests, managed funds are investment vehicles where investors pool their money into a single vehicle and these funds are then managed by a professional manager. The manager has a specific set of criteria and objectives (known as a mandate ) under which they invest for the benefit of their collective investors. In very simple terms, investors pool their money and then give it to a professional to manage and try to deliver returns. Although often sounding technical, bonds are actually quite similar to basic loans which most people would be familiar with. That is, someone in need of money agrees to borrow the funds from someone else in return for paying interest on the loan, plus paying back the principal at the end. The term bond is essentially the name given to basic loan arrangements but done on a very large scale for example, usually one borrower (such as the Australian Government) and many lenders (such as super funds or managed funds). A key factor to understanding bonds is that they are tradeable. This means the bond (loan) can be bought and sold on the market and as such, the value of that bond can rise or fall depending on outside factors (such as interest rates). So while bonds are an excellent way to earn a fixed, strong rate of return, investors need to consider that the value of the bond can rise or fall in the short term. Another characteristic of bonds is that they have a limited set lifespan and are repaid at the end of their borrowing term (just like loans). From an investor s point of view, this means you need to consider how long you want your bonds to be earning for you. It is common for investors to hold a portfolio of bonds to diversify the earnings rate and expiry dates across several different bonds. Pg. 7 Pg. 7 Sentinel Group - Guide To Options Trading

8 7 Stockmarket Investments That Can Earn Income 6. ASX-LISTED BONDS (CONT.) Investing directly in bonds was previously restricted to large and sophisticated players but investors can now buy a range of different bonds in lots of $100 so virtually anyone can own bonds. If you re interested in lower risk income generating investments via the stockmarket, speak to your stockbroker. people insure their houses against unforeseen damage that may occur in the future by paying an insurance company a fee. The insurance company is therefore the speculator who takes on the uncertainty, while the home owner hedges their risk now. Of course that is a very simplified description and options are more varied and complex than the above example but the key point to take out of it is that many investors are happy to pay fees (called premiums ) to hedge their risks. So for investors looking to earn income, there is an avenue to take on risk of varying levels and earn premiums. More so than with any other stockmarket investment, dealing in options is where you should seek the advice and help of a specialist stockbroker. 7. OPTIONS STRATEGIES Options are one of the more complex investment alternatives available to investors in the stockmarket but they can be very effective tools when used correctly. In very simple terms, options are rights or obligations to transact in a share, at a set price, at a future point in time. They are therefore contracts to do something in the future, that are agreed to in the present (now). Options exist because nobody knows for sure what will happen in the future but from an investing point of view, it is often good to fix things now to create certainty. Options therefore create a trade-off for different participants in the market one is the investor looking to lock in certainty now (called a hedger ) and the other is someone willing to take on the investor s uncertainty in return for a fee (called a speculator ). While that may sound complicated, there are many real world comparisons that echo options. The most common is insurance Pg. 8 Pg. 8 Sentinel Group - Guide To Options Trading

9 Taking The Next Step If you think investing in the stockmarket might be right for you, you will need to open an account with a stockbroker in order to transact (much like you would need to find a bank to open a deposit account). Stockbrokers can offer three main services: An account to buy, sell and hold your investments Advice on investments (including portfolio creation) and operating in the stockmarket Ongoing investment management and support 7 Stockmarket Investments That Can Earn Income As you can see from this introductory guide, there are a wide range of choices, risks and strategies to consider when investing. A stockbroker s role is to help you work out what s right for you and assist you, both now and in the future, in making investing easy and successful. Sentinel Stockbroking is able to assist everyone from first time investors to experienced market professionals. To find out more or get started investing, please contact Sentinel Stockbroking: website: sentinelgroup.com.au info@sentinelgroup.com.au phone: Pg. 9 Pg. 9 Sentinel Group - Guide To Options Trading

10 Visit: DISCLAIMER Please note that this Fact Sheet is designed as a beginner s introduction to investing in shares and as such, many technical descriptions have been simplified and generalised for ease of explanation and understanding. The information contained within is not advice and is purely a factual overview. Before taking any action, a prospective investor should first speak to their financial adviser and also consider whether any investment decision is appropriate for them personally. Head Office Ground Floor 45 St George s Terrace Perth Western Australia 6000 Sydney Office Level 26 1 Bligh Street Sydney NSW 2000 Mailing Address Sentinel Stockbroking GPO Box 2514 Perth WA 6001 Contact T F E info@sentinelgroup.com.au