If you are ready to take care of your financial well-being and want to learn about defensive investments, this article is for you!
Why is your financial well-being important?
Maslow’s hierarchy of needs suggests that the most basic physiological and safety needs are needed to be met before we can fully enjoy life. This means investing in your financial well-being is crucial for a stress-free life. Once you’ve achieved financial stability for retirement you can do many things like focusing on your hobbies, spending time with your family, or travelling. By taking the time to invest in your financial future, you can open a world of opportunities and live the life you’ve always dreamed of.
What is investing?
Investing is one of the ways that you can protect and grow your money to achieve your goals. Investing is putting resources into a venture that you expect will make you more money over time. Broadly speaking there are two types of assets to invest in, growth and defensive.
Growth investments are assets such as property or shares. Their value may grow over time. Still, it may also decline a lot over time; so, although there is the possibility of making a considerable profit from them, there is also a high risk of losing your money. Therefore, referring to them as high-risk assets would be much closer to reality and much less misleading. Real estate and shares are the growth assets most investors know, but what if you cannot afford the time to recover from losses from risky investments?
What are defensive assets?
Defensive assets are financial instruments that are more resistant to economic recessions and less dependent on market volatility. They are used to protect investment portfolios from uncertainty in the economy.
Examples of defensive assets include:
- Bonds: They are fixed-income securities issued by corporations and governments and they yield a fixed rate of return
- Cash: Having cash or cash-equivalents like money in a savings account could give you liquidity and flexibility in case of an emergency
- Gold: It is a precious metal that is perceived as stable and valuable and is considered a haven during economic turbulence
- Defensive shares: These are shares from companies that produce essential goods and services like consumer staples that tend to be resilient during economic downturns.
Although these investments may not have high returns during economic expansions, they are less dependent on the volatility of the markets, therefore they perform better during times of recession, and they are a smart choice for risk-averse investors, such as those who are near retirement.
What should I consider when investing?
It would help if you asked yourself the following questions:
- What are my future goals?
- How much risk can I take with my investments?
If you are young and starting out your working life, there is time to make up for losses from investing. The risk you can take goes hand in hand with time. The more time you have, the more time you have available to make up for losses from risky investments.
However, if you are close to your goal, there is little time left to earn back losses from investments in volatile markets. The stakes are higher; you would be gambling with your life savings if you were to invest in high risk assets a few years away from your goal. Therefore, a lower risk approach may be much more convenient for you. Consider investing in low-risk assets.
What are low risk assets?
While there is still a risk, low risk assets tend to be backed by a commitment to pay back from the bank or issuer of the asset. They include savings accounts, term deposits, and some government issued bonds.
About savings accounts
Let’s start with the most basic low risk investment option: a high yield savings account.
A compound interest savings account could be great to keep your cash flow, your living expenses and to help you during emergencies. In fact, saving enough money in a high interest savings account is the first step to financial well-being. Therefore, putting enough capital into a savings account for 3 to 6 months of expenses as an emergency fund would be worth considering. Compound interest savings accounts yields in Australia range from 3.75 per cent to 4.35 per cent.
Earning interest on your cash is essential because as time passes, the prices of goods and services usually increase across the economy, making your money lose its purchase power. Regardless of how much interest savings accounts pay you; more is needed to keep your money’s purchase power if the rate you receive is below the inflation rate. Therefore, once you have an emergency fund, it would be good to invest in defensive investments.
About term deposits (TDs) or Certificates of Deposit (CDs)
Like savings accounts, TDs are covered by the Australian Government Financial Claims Scheme. However, they are different because they lock your money away during a fixed term. In addition, because they are less flexible, they pay you a slightly higher interest rate to compensate you for the less liquidity offered.
About Government Bonds
Government Bonds are defensive investments as they are backed by the Australian Government. They are how the Government (at federal and state and territory level) finances their operations or projects. For example, the Australian Government wants to build a fast-rail network but needs a lot of money to fund this project. So, the Government can ask for a loan from individual citizens, banks, and financial institutions by issuing debt. The lenders receive fixed interest payments (coupons) and their initial investment in exchange. Australian Government bonds have a high rating from Moody’s; according to the Treasury Moody’s affirmed Australia’s AAA rating in June 2022. Australia’s good rating is due to its economic indicators, political stability, fiscal policy, and debt levels. There are various kinds of government bonds including, bonds from the federal government (treasury bonds), state and territory bonds (semi-government bonds), READ MORE ABOUT GOVERNMENT BONDS HERE
About Corporate Bonds
Corporate bonds are how companies fund themselves to operate or finance new projects like expansions or creating new products. Sometimes, a company needs much more money than a bank can lend, so it issues debt. The company asks for loans from individuals, big banks, or financial institutions. It promises to pay in exchange a set of fixed interest payments (coupons) throughout the bond’s life and the initial principal invested.
How should you allocate your assets?
When we invest, we cannot control external conditions like the economy as it fluctuates in cycles, and there is never certainty about what will happen next. If there is a recession, an asset class may perform better than others. On the other hand, if there is an expansion, some assets do better in that environment. Therefore, you must keep several types of assets from different industries in your investment portfolio. When some of your assets lose value, the loss is compensated by growth in other assets.
In conclusion, you could have an emergency fund in a high yield savings account and then invest in corporate bonds to set up a defensive strategy in your investment portfolio. Once you have set up your defensive strategy, you can consider your risk tolerance and invest in higher risk assets if you still have time to recover from losses.
Knowing about defensive investments enables you to become a more empowered investor and to take control of your money.
Before investing, seek professional financial advice.
Disclaimer: The information and any advice provided in this article has been prepared without considering your objectives, financial situation or needs. Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.
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