You have probably heard the terms ‘growth investments’ and ‘defensive investments’. What do they mean, exactly?
All investments are divided into one or the other of these two categories. A growth investment is one that is expected to grow in value over time. People purchase growth investments in the hope that doing so will increase their wealth in the medium to long-term. Common types of growth investment include shares and residential or commercial property.
Growth assets can be held directly or indirectly via some form of management. Property investments are more likely to be held directly, whereas share-based investments are often more likely to be held indirectly. For example, if you invest in growth assets via a managed superannuation fund, that is known as an indirect form of investment.
That is not to say that share-based investments cannot ever be held directly, or that property investments cannot ever be held indirectly. It is just to say that share-based investments are more likely to be held indirectly.
The Key Element of a Growth Investment
The expected rate of growth for a growth investment needs to be higher than both the rate of inflation and the holding costs of the asset. If one of these conditions is not met, the investor may well be better off storing their wealth in a defensive asset. After all, why invest in a risky asset that is unlikely to make money for you?
As a general proposition, growth investments are usually seen as higher risk than defensive investments. Investment risk has quite a technical and complicated definition. However, as most people understand it, the concept is quite simple. Most people define investment risk as the possibility that your investment will fall in value over time. The higher that possibility, the greater the investment risk.
Common sense tells us that people will only take on investment risk if there is a prospect of making a positive investment return. People will only risk losing money if they believe there is an even better chance that they will make money. As a result, people usually draw a connection between risk and return: investment assets with a prospect of greater returns tend to have greater risk attached to them.
This is why growth investment assets are not for everybody. A growth investor needs to be able to tolerate the risk of losing some or all of their investment. If a partial or full loss of your investment money would be catastrophic, you should avoid growth investments.
Over time, we have developed various ways in which to ‘manage’ (or try to reduce) at least some of the risk inherent in growth investments. One way or another, these ways usually involve diversification. Diversification usually means one or both of (i) buying more than one type of asset; and/or (ii) buying and selling assets at more than one point in time. The key term here: ‘more than one.’
Growth investing involves the risk of losing money. Growth investments should only ever made after proper consideration and after you seek qualified advice. If you are interested in pursuing some growth investments, please make a time to talk to us. We can assist to make sure that the growth investment is appropriate and that you are doing everything possible to manage your risk.