Spend­ing wind­fall

Western Suburbs Weekly - - Business -

Q. I re­cently re­ceived some money via an in­her­i­tance and have started look­ing at in­vest­ment op­tions. I have never re­ally had much to do with in­vest­ing be­fore. Can you please ex­plain the dif­fer­ence be­tween shares and bonds? Sarah - Su­bi­aco A. Shares rep­re­sent own­er­ship in a com­pany.

The ben­e­fit to the com­pany is that they can use your money to fi­nance growth and de­vel­op­ment, hope­fully earn­ing greater prof­its as a re­sult.

The ben­e­fit to you comes via div­i­dends, which are pay­ments out of the profit the com­pany makes, as well as the po­ten­tial for selling the share at a higher price in the fu­ture.

Depend­ing on the risk in­volved with the com­pany and its ac­tiv­i­ties, you ex­pect greater re­turns with higher risk.

Keep in mind that com­pa­nies aren’t re­quired to pay div­i­dends and start-up com­pa­nies of­ten don’t pay div­i­dends for a few years as they grow!

Bonds rep­re­sent a loan – of­ten to the gov­ern­ment – where you give them money now, in re­turn for reg­u­lar coupon pay­ments, plus the face value of the bond at the end of the set term (the bond’s ma­tu­rity date).

In Aus­tralia the gov­ern­ment bonds are called Ex­change-Traded Trea­sury Bonds and in­clude the coupon in­ter­est pay­ment ev­ery six months.

Be­cause the coupon in­ter­est rate is fixed, bonds can sell at ei­ther a pre­mium or dis­count in re­la­tion to their face value, depend­ing on changes in the in­ter­est rate for other in­vest­ments over the life of the bond (if the re­turn on other in­vest­ments rises com­pared to the price of the coupon rate, the value of the bond de­creases).

Gov­ern­ment bonds will of­fer lower re­turns than cor­po­rate bonds and shares, be­cause there is ba­si­cally zero risk that the gov­ern­ment will de­fault on the loan.

As with any in­vest­ment, lower-risk in­vest­ments gen­er­ate lower re­turns.

Troy.MacMil­lan@twd.com.au

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