When constructing a portfolio investors should ‘loan’ and not just ‘own’ assets.
When we consider investing, we often think about buying assets to own. For example, property investment often involves buying physical properties and buying shares involves buying portions of a listed company which are held in our own name.
But investing isn’t just about owning assets, it also involves lending money. You can loan your money by buying corporate bonds through XTBs, which are traded on the ASX like shares. Bonds allow investors to loan their money to companies and earn a known rate of return.
While you might not think of it this way, choosing to invest some funds in a term deposit is another form of loan. You’re essentially loaning your cash to the financial institution for an agreed period of time and in return you’ll receive a fixed rate of return. Term deposits are lower risk than corporate bonds, but they also generally offer a lower return.
So, why should you consider loaning as well as owning when you’re constructing your portfolio?
Here are three reasons why you should be a lender, not just an owner:
Investing in products like bonds as well as other assets like shares and property will help ensure your portfolio is well diversified. Bonds are considered to be defensive assets, as they’re lower risk. Stocks and property are seen as higher-risk growth assets.
Investing in a mix of defensive and growth assets helps to minimise your investment risk, as they each have the tendency to behave in different ways and their performance is often independent of one another.
When you’re loaning money in the form of a corporate bond or a term deposit, you’ll have a fixed rate of return on that money. Not only will you have a fixed rate of return, but you’ll also know which dates you’ll receive your income payments. Because these products offer fixed rates of returns, they’re not affected by the same level of market volatility as shares.
While shares and property might be crashing or rallying, the rate of return on your XTBs generally remains stable. Having a mix of assets with fixed interest rates in your portfolio can provide much smoother returns. And you’ll have fewer sleepless nights worrying about your portfolio!
Protect what you have
If you’re young, it makes sense to invest a large portion of your portfolio into growth assets like shares. You have a lot of time ahead of you to ride out any market volatility. However, if you’re closer to retirement age, investing heavily in shares is a high-risk strategy. If the market falls, you stand to lose a large chunk of your nest egg with little time to make it back.
Instead, as you approach retirement, it’s important to protect what you’ve built up, rather than try to keep building. This is where loaning comes into play. Loaning your cash to companies in the form of corporate bonds will still offer returns, without putting your entire portfolio at risk.