The Australian Securities Exchange reports that almost 9 million Australian adults hold investments outside their home and superannuation.
And yet, Australia’s financial literacy is declining. The HILDA survey measures financial literacy as part of its ‘household wellbeing’ category. In 2020, when the last financial literacy questionnaire was completed, we learnt had been a significant decline since 2016. Experts suggest that a 70% decline in participation in economics electives at high school might have something to do with the decline, but others think that it might be the natural result of a long period of, relatively speaking, favourable economic conditions.
Regardless of why our financial literacy is declining as a nation, the ability to assess an investment choice is critical to its success.
How do we identify risks when we invest?
When we talk about risk, we’re talking about the idea that an investment might make less money than expected, or fall in value over time. We can often identify the risk profile of an investment broadly by asset class, and further refine our understanding of risk by conducting more specific research.
The two major principles that help investors assess risks are these:
- Knowing your own appetite for risk will help you make informed choices about those assets in which you invest
- A diversity of investments will limit risk across your portfolio—if one investment performs badly, others may yet do well, softening the impact of that underperformance on your overall finances
Different expectations of risk are associated with different classes of assets: low-risk assets, like cash, or fixed interest, typically attract a predictable but modest reward; higher-risk assets, like shares, and alternative investments like cryptocurrencies, might attract an unpredictable but potentially higher reward. In Australia, real estate is also a common investment, and is typically considered low-to-moderate risk, but it lacks other characteristics associated with cash or fixed interest—we cannot easily withdraw our money from a property investment if we need it, for example.
What kind of research do you use to assess investments?
Identifying risks associated with defensive investments like cash is relatively straightforward. People rarely need to perform research when they’re investing in a high-interest savings account!
With higher-risk investments, however, assessing risk can be much more complicated. That’s where research comes in—especially when you’re looking at alternative investments like private equity or venture capital.
There’s a lot of information out there that can help you determine how risky a particular investment might be, but it can be difficult to find, access and collate into a meaningful big picture.
When investigating investment opportunities, consider:
- Company credit scores and histories
- Information like court judgements, loans, tax defaults or mercantile enquiries
- Year on year revenue and profits
- Any news media stories about the market, industry conditions, changing regulations or specific organisation
A company that has a strong credit history and consistently turns a profit will likely be a lower-risk prospect, and will be significantly more likely to provide shareholders with predictable dividends each year—however, information uncovered through more holistic sources like news media might lead you to predictions about the future that could encourage a higher-risk investment, too.
Venture capital investors can have a more difficult decision before them, because venture capital is typically provided to unproven organisations with little history behind them—start ups and emerging technologies are common sites of venture capital investment.
In this case, it can pay not just to keep an eye on news media, but also to investigate where the people heading the project have come from, rather than the organisation itself. You might ask yourself ‘What were their previous roles? To whom have they been connected? Have they been a steady hand on the wheel, or a disruptive influence?’ Research into the performance of those companies might help you better assess risk.
And if all this research sounds like an awful lot of work, there are tools out there that can help you bring many sources of diverse, up-to-date information into one convenient place.