INVESTMENTS
Building a Portfolio
There are a number of steps to follow to build a portfolio that suits your financial goals and preferences. These steps are illustrated in the diagram below:

An explanation of these key steps is provided below.
It is important to understand the main asset classes and how they can affect the returns and risk of your portfolio. The types of asset classes include:
- Shares
- Property
- Bonds (or fixed interest as they are often called)
- Cash
There may be asset types within each asset class. For example, within shares, there is a choice of Australian and international shares and within international shares, there is choice of specific regions or countries like China or emerging market shares.
Generally ‘growth’ assets like shares and property provide the prospect of higher returns over the long term compared to ‘safer’ assets like bonds and cash. However growth assets have a higher level of risk including the risk of capital loss and more ups and downs in returns particularly over the short term. ‘Growth’ assets are only appropriate if you have an investment time horizon of at least five years due to their higher level of inherent risk.
Shares: Shares represent part ownership in a company and usually provide income payments through dividends and can produce growth if the share price increases.
For Australian companies, these dividends can be franked, which means that you receive a tax credit for the tax already paid by the company so that you are not taxed twice (once at the company tax rate and again at your marginal tax rate). If your tax rate is less than the company tax rate (currently 30%) you will receive a refund for the extra tax paid by the company. If your tax rate is higher you may need to pay some extra tax.
Property: An investment in property provides you with ownership in a property or a number of properties through a managed structure. Property investments allow you to benefit from the rent received by the properties as well as the change in the valuation of the property over time. The returns of these properties will depend on the quality of the tenant and the rent paid as well as the location and type of property such as residential, industrial or commercial.
Bonds (fixed interest): A bond is a tradeable debt security, usually issued by a government, semi-government or corporate body to raise money. Investors in the bond have effectively lent money, for which they receive a fixed rate of interest over a set period of time. The bond is repaid with interest on the predetermined maturity date.
For example, if you invest in a 5 year bond paying 3% coupon you will pay $1,000 to invest in the bond. In return, you will receive $30 (3% of $1,000) each year. At year 5, you receive the coupon of $30 plus the original $1,000 outlay.
It is possible to experience capital losses from a bond investment if it is cashed before maturity and interest rates have risen or capital gains if the reverse occurs. They are not as safe as cash.
Cash: Cash is one of the safest investments. Cash compared to other assets tends to provide lower variability in returns, high level of security on the capital invested and acts as a more defensive investment. This reduces investment risk so the money is available when you need it, with a minimal potential for capital loss.
The returns from the various asset classes are provided in the form of income and/or growth resulting from a change in the price of the investment. Some investments like cash will only provide income returns while the return from other investments may include a mix of income and capital growth.
Income returns can include interest from cash and bonds, rental income from property and dividends from shares. Managed fund may also pay realised capital gains as part of the income return.
This income is included in your tax return and is taxed at your marginal tax rate. If franking credits have been derived these will be passed onto you and can help to reduce tax payable.
If an investment is sold, this may create a capital gain or loss depending on whether the price of the security or unit price of managed funds has changed since investment. If a capital gain has been realised on units held for more than 12 months a 50% capital gains tax discount will apply unless the units were owned by a company.
Diversification
You can invest in a mix of asset classes or securities as a means of ‘diversifying’ your portfolio. Diversification is a key investment principle used to manage the risks of a portfolio and involves investing in a variety of assets and investments that perform differently to each other over time. It is often described by the proverb “Don’t put all your eggs in one basket”.
It also allows you to have an exposure to a spread of assets and securities including both ‘growth’ and ‘defensive’ assets. It means that you avoid taking big bets in one or a few asset class and/or investments that may adversely affect your returns if it underperforms.
Diversification can reduce the risk in your portfolio but it will not eliminate the risks. Your portfolio is likely to experience ups and downs in returns over time but by a lower level of variability.

You can access assets and/or securities by buying the investment directly or via a managed trust. Direct investments involve buying the security such as a specific share or property such that you are a part or full owner of the security. As an example, you can become an owner in a specific company by buying its shares on the Stock Exchange which entitles you to receive dividends and vote at General Meetings (depending on your share structure).
An alternative means of gaining exposure to assets is via a managed fund. A managed fund is a professionally managed investment portfolio that pools the money of multiple investors. A fund manager is appointed to manage the fund including selection of the underlying investments and maintaining client records. By pooling money with other investors you may gain access to investments not normally available if you invested directly or enable you to achieve a greater level of diversification.
If you invest money into a managed fund you will receive a number of ‘units’ in that fund. The number of units you receive is calculated as the amount of money you invest divided by the unit price on that day. This is why managed funds are also often called “unit trusts”. The unit price may increase or decrease in line with the value of the underlying investments.
Each investment approach has its advantages and disadvantages that you should consider. These will include the implications for fees and investment control.
Investing directly in securities may require you to actively review and manage the investments in your portfolio on a regular basis. You may be required to make decisions and changes to account for corporate action events in the case of buying shares directly such as takeovers, rights issues and share purchase plans. This can require you to have the time and inclination to manage your direct investments portfolio. On the flip side, the advantage provided by a managed fund is that you do not need to devote the time to be actively involved in the investment decisions.
There are a number of factors that you need to consider to determine the most appropriate investment for your personal preferences and financial goals. A key driver of this decision is your risk profile which measures your attitude towards risk. Your risk profile will depend on how you feel about a range of different issues such as:
- Your comfort and knowledge of investment markets. The higher your knowledge, the more comfortable you may be investing in riskier assets like shares and property.
- Your preference for capital growth (compared to capital preservation and/or income). The higher your preference for growth may be better suited to investing in riskier assets that offer a higher potential for capital growth.
- Your level of concern when markets suffer a loss. If you are likely to sell and feel stressed from this loss, then a lower exposure to risky assets may be suitable.
- How important it is to you for your investments to keep pace with inflation. If this is important to you, then shares and property are more likely to meet this need.
- Your investment time horizon. If you are investing for the long term (at least 5-7 years), then you may consider investing in shares and property. Generally, risky assets are not suitable if you are investing for shorter periods of time and a higher level of investment in cash and bonds may be more suitable.
There are various ways of owning investments and these can include in your own name, in your spouse or kids’ names, via a family trust, superannuation or private company. There are a number of issues to consider when determining the most appropriate structure to hold the investments and these include the following:
- Tax
- Fees and costs
- Liabilities and responsibilities
- Flexibility and complexity
- Estate planning
Once you have decided on your portfolio, there are various approaches to investing and withdrawing your money.
If you are concerned about the ups and downs in financial markets and are unsure about whether it is a good time to invest in risky assets, you can consider investing using a ‘dollar cost averaging’ approach. This involves investing a set amount regularly over a period of time rather than investing the full amount at a single point in time. In this way, you can avoid trying to time your entry into financial markets. By making regular investments over time you may be able to minimise the risk of investing all your money during a market peak. This can help to minimise investment risk and average the purchase price of your investments by buying more assets when prices are low and fewer assets when prices are high.
If you are withdrawing funds from your portfolio, you can use a regular drawdown strategy that has similar benefits to dollar cost averaging (but in reverse). That is, you can withdraw funds over time rather than withdrawing the full amount at a point in time. In this way, you can minimise the risk of withdrawing all your funds from financial markets at the bottom of the market.
Your portfolio can benefit from ‘compounding interest’ particularly if you reinvest your income returns. If the interest you receive is added to your initial investment, you can receive interest on the total amount and effectively receive interest on the interest reinvested. This is called ‘compound interest’ and has the effect of increasing your overall returns. The more frequently that interest is calculated, the higher will be the compounded returns.
Risk
Generally, risk and return are positively correlated. That is, the higher the risk associated with an investment, the higher the expected return and vice versa (however this is not always the case). This relationship is called the ‘Risk versus Return Trade Off’ (see Chart 1 below) and is a factor that is taken into consideration in defining your tolerance to risk.
Investments such as shares may offer higher returns over the longer term, but there is a greater inherent risk. In contrast, cash and fixed interest investments are considered to be less risky, but offer lower returns.
When deciding on an investment, it is important to understand the expected risk and likely returns from the investment and determine how this fits with your personal situation and financial needs.
Investments are expected to provide a return, but this return will come with a certain level of risk. Risk means different things to different people and typically it is referred to as either the uncertainty of the return or the risk of losing your capital.

Chart: Long-term asset class risk-return trade-off
*Risk is measured by standard deviation.
Source: Morningstar Investment Management Australia Limited – October 2017 Capital Market Assumptions (20-year investment timeframe)
*Return expectations for Australian Equities incorporate franking credits.
The relationship between risk and return is demonstrated in the graph below.
As a general rule, the higher the potential return from an investment, the greater is the investment risk and the probability of experiencing capital losses.

The first step in determining whether an investment is appropriate is to understand the relationship between risk and return, and then to determine the level of risk and return that you are comfortable with. This also requires an understanding of the level of risk you may need to accept to generate the likely returns required to meet your financial goals.
Risk means different things to different people. Most people think of risk as the chance of losing their capital.
However, in investment terms, risk is often described as the level of unpredictability of returns or the chance that returns will be different (higher or lower) than expected.
There are many kinds of risk. Some of these include:
- Capital risk: losing your invested capital
- Market risk: needing to sell an investment at a time when the price is low
- Inflation risk: the investment’s rate of return does not keep pace with inflation
- Interest rate risk: Price sensitivity of a security as a result of a change in interest rates
- Liquidity risk: limitations on access to funds for a period of time
- Legislative risk: changes in laws including tax and superannuation which may make investments less attractive
- Default risk: the failure of an institution in which an investment has been made
Risk can also be described as the chance that you will not achieve the investment returns needed to meet your financial objectives. While some people may be more comfortable with accepting low levels of risk, the potential consequence may be that the returns achieved are insufficient to meet their financial objectives. For example, this may mean that the required level of savings is not available when needed to pay for items, such as retirement or children’s education expenses.
Example 1
Amy has $400,000 to invest. She plans to use the funds in 10 years’ time and needs her investment to grow to at least $800,000.
If Amy decides to invest in defensive (low risk) assets that are expected to return 5% per annum after fees, her portfolio is expected to grow to $651,558. This is not enough to meet her goals.
Alternatively, Amy could invest in higher risk assets that are expected to return 8% per annum after fees. In this scenario, Amy’s portfolio is expected to grow to $863,570 and be sufficient to meet her goals.
This represents a difference of $212,012 and the potential to meet her goals.
The higher risk investments are more likely to help Amy achieve her financial goals. However, Amy needs to accept the trade-off of greater unpredictability of returns over the 10 year period and the potential for capital losses or poor performance.
One way of looking at risk is to look at the possibility of negative returns from the investment. The probability of negative returns from an investment will also depend on how long the investment is held. The probability of losses reduces the longer the ‘risky’ investment is held.
Below is a table of Centrepoint’s Strategic Asset Allocation and Risk Profile Characteristics. The table shows that the higher risk portfolios are more likely to result in a negative return in 20 years. For example the Defensive portfolio is expected to produce a negative return 1.9 times over 20 years and the High Growth Plus portfolio is expected to produce a negative return 5.2 times over 20 years. Over the long-term all risk profiles are expected to produce positive returns.
Risk Profile Characteristics

Capital Gains Tax
Most investments (assets) generally provide you with income on a regular basis. But some investments, like shares and property, can also increase in value. This increase is called growth or capital gain.
If you sell your investment for more than you paid for it then you realise a capital gain and you may have to pay tax on this gain. Capital Gains Tax (CGT) is payable on the taxable portion of a capital gain if you acquired the investment

If you bought or acquired an asset before 20 September 1985, the CGT rules do not apply. Any capital gain can be received by you tax-free.
You are deemed to acquire an asset if you:
- Buy it
- Inherit it
- Build it, or
- Receive it as a gift
You are deemed to dispose of an asset if you:
- Sell it
- Give it away, or
- It is lost or destroyed
If the transaction is done at a price lower than the asset’s market value, the market value will be deemed to be the acquisition or disposal price, even though this is not the amount of cash you received.
Example
Horace purchased a parcel of shares for $10,000 in May 2004. The shares increased in value and were worth $24,000 in November 2009 when he decided to gift the shares to his son.
Horace did not receive any payment for the shares, but for CGT purposes the shares are deemed to have been sold for $24,000. This means he has realised a capital gain of $14,000 and needs to calculate how much tax is payable on this gain.
Gains on the following assets acquired on or after 20 September 1985 are likely to be subject to CGT:
- Shares
- Managed funds
- Property investments
Not all assets which increase in value will be subject to CGT. Two main assets that are exempt from CGT are:
- Your principal home, and
- Assets purchased before 20 September 1985 (pre-CGT assets)
Your home can continue to be exempt from CGT for up to six years after you move out, provided you do not buy another home that you elect to claim the exemption on.
The taxation of a capital gain depends on how long you have owned the asset.
If you have held the asset for less than 12 months the full amount of the gain less any capital losses (from current year or carried forward from previous years) is added to your assessable income in your tax return. This amount is taxed at your marginal tax rate.
If you have held the asset for 12 months or more, capital losses (from current year or carried forward from previous years) are deducted from the capital gain, then only 50% of the net gain is added to your assessable income and taxed at your marginal tax rate.
Note: if your asset was purchased before 21 September 1999 you could choose to calculate the taxable portion of the gain using an indexation method, but tax advice should be sought.
Example
Horace (in example above) had held the shares for more than 12 months. So his taxable capital gain is reduced by 50% to $7,000. This amount is added to his other assessable income and is taxed at his marginal tax rate.
If Horace had only owned the shares for less than 12 months, tax would be payable on the full $14,000.
If the asset is owned in the name of a company, the 50% exemption does not apply. Further tax concessions may apply if it is a business asset.
If you sell an asset for less than you paid for it, you may realise a capital loss. A capital loss can reduce your taxable capital gains on other assets (as explained above) but cannot be used to reduce tax on other income sources. The reduction is done before you claim the 50% exemption.
Example
Last year Horace sold an asset which realised a capital loss of $2,000. This can be used to reduce his taxable capital gain as follows:
Taxable capital gain = ($14,000 – $2,000) x 50% = $6,000
Horace will only add $6,000 to his assessable income and pay tax at his marginal tax rate on this amount.
If you cannot use the loss in the year that it is realised, the loss can be carried forward to reduce taxable capital gains in future years. However, it is better to use losses as quickly as possible because the value of the loss diminishes over time with inflation.
Types of Investments
Managed Funds

A managed fund is one type of ‘managed investment scheme’ (MIS), which is a professionally managed investment portfolio that pools the money of multiple investors. Investment/fund managers are appointed to manage the money within the fund including the selection, buying and selling of the underlying investments.
By pooling money with other investors you may gain access to investments not normally available if you invested directly or enable you to achieve a greater level of diversification. The managed fund structure also allows for the professional management of your money.
If you invest money into a managed fund you will receive a number of ‘units’ in that fund. The number of units you receive is calculated as the amount of money you invest divided by the ‘entry’ unit price on that day. This is why managed funds are also often called ‘unit trusts’. The unit price may increase or decrease in line with the value of the underlying assets.
The investment/fund manager or administrator of the fund, may offer a range of investment options that you can choose to invest in. Each option has different investment goals, timeframes, risk profiles and underlying assets.
Some managed funds may provide a diversified allocation to asset classes based on a risk level. Examples of these include a ‘balanced’ fund which invests approximately half of the money within the portfolio in growth assets such as share and property, with the remainder in more defensive assets such as cash and bonds.
Other funds might invest in a specific type of asset (e.g. Australian shares, international shares, property or cash). There may be different investment styles used to manage the portfolios such as value or growth investing.
When investing in a managed fund you need to choose which options are best suited to your personal preferences and financial goals. This includes consideration for:
- Your risk profile
- Your investment time horizon
- Your need for diversification across asset classes
- Your preference to invest in a particular type of investment or asset class
The Product Disclosure Statement (PDS) provides you with information on the investment options and may help you to determine the suitability.
The underlying assets of the managed fund might produce income (including interest, rental income, realised capital gains and dividends) and/or capital growth.
The fund manager will deduct any applicable fees and expenses from the income generated and the remainder is more often than not, distributed to investors (unit holders).
This income is included in the investor’s own tax return and is taxed at the investor’s own marginal tax rate. If franking credits have been derived these will be passed onto investors and can help to reduce tax payable.
If units are sold, this may create a capital gain or loss depending on how the fund unit price has changed since your initial investment and any investment thereafter. If a capital gain has been realised on units held for more than 12 months a 50% capital gains tax discount will apply unless the units were owned by a company.
Managed funds have a number of advantages that allow you to select options that suit your specific needs and objectives. These benefits may include:
- Diversification: Managed funds can provide you with a diversified portfolio that may invest across a range of asset classes and securities
- Wide choice of investments: Wide choice of asset classes and diversified portfolios
- Specialists: Access to specialist investments and investment styles
- Tailored portfolio: Can have a tailored portfolio where specialist managed funds are chosen (e.g. infrastructure, emerging markets, small caps)
- Professional investment manager: Team of professional investment managers responsible for the investment selection, review and monitoring. This also includes risk management
- Active performance: Active managed funds will actively manage investments to take advantage of the changing market outlook and therefore have the potential to outperform their index
- Low level of participation: There is a low level of participation and time involvement required by you in the management of the managed fund compared to investing directly
- Regular investments: Many managed funds allow regular investments including small minimum amounts. This can assist you if you are investing using a ‘Dollar cost averaging’ approach and/or a regular savings plan
- Tax statements: Managed funds provide tax statements to assist with you with completing your tax returns
There are a number of risks and disadvantages of managed funds to be aware of. The key risks will be determined by the nature of the managed fund including the asset classes and securities that it invests in. The risks and disadvantages include:
- Market risk: The performance of the managed fund will be affected by the assets and securities that it invests into. If it invests in ‘growth’ assets like shares and property, it has the potential to provide higher returns over the long term but will also have a higher level of risk including the risk of capital losses compared to more secure investments like cash and bonds.
- Limited control: You have no control over the individual investments that are bought and sold.
- Tax management: You have no control over the timing of sales and purchases of assets or assets selected to be sold. This may affect the capital gains tax outcome of the managed fund.
- Capital gains in distributions: The distributions paid from a managed fund may include a return of capital which can be less tax effective for investors.
- Limited transparency: There is limited transparency of the underlying portfolio and investments. A managed fund will tend to report of the securities and assets held in the portfolio but this tends to be reported with a lag.
- Higher fees: Fees can be high due to the management and administration fees and buy-sell spreads.
- Currency risk: Movements in the relative value of international currencies can influence the value of international assets.
Gearing risk: Some managed funds may borrow funds to increase potential returns. This gearing can magnify both gains and losses.
Growth or Value Investing
Investors must consider whether they prefer to invest in fast-growing firms or underpriced industry leaders. Each will have varying risk and return characteristics and will perform differently at different times in a market cycle. Investors must determine which strategy best suit their individual needs.
The growth style of investing looks for high-quality companies that have high earnings growth rates, high return on equity, high profit margins and low dividend yields. There are however no guarantees going forward. Companies that have all of these characteristics are often innovators within their field/industry and make lots of money. It is thus growing very quickly, and reinvesting most or all of its earnings to fuel continued growth in the future.
The value style of investing is focused on buying strong companies at reasonable prices. Their price however has fallen due to the company or industry falling out of favour with investors or perhaps the economic cycle not favouring a particular industry at that point in time. Investment managers look for a low price to earnings ratio, low price to sales ratio, and generally a higher dividend yield. The main ratios for the value style show how this style is very concerned about the price at which investors buy in. The idea behind value investing is that stocks of good companies will bounce back in time when the true value is recognised by other investors and the market.
Quality and Lower Volatility Investing
In recent years, we have noticed an increase in other styles of investing. These styles include Quality and Lower Volatility investing and, in many cases, some products will focus on both.
Investing in Quality companies is usually associated with companies with efficient management, sound balance sheets, low debt, profitability, and strong cash flows. Quality strategies seek to provide excess returns by investing in companies that are better positioned for short- and long-term growth.
Lower Volatility investing targets companies with less volatile share prices that typically fall less than the share market during share market declines.
Higher quality and lower volatility portfolios aim to deliver strong up-market participation and down-market protection. These portfolios also tend to blend well with growth and value portfolios to improve overall portfolio diversification.
Investment Bonds

Investment bonds, or insurance bonds as they are also known, are issued by life insurance companies. They have features similar to a managed fund combined with a life insurance policy. They can be a tax effective way to invest if certain rules about contributions and withdrawals are followed.
Investment bonds are used for a range of purposes including:
- A medium to long term lump-sum or regular savings plan
- A tax effective investment for investors on high income earners
- Investment bonds can be taken out by parents, grandparents and the like on the life of a child. The bond can be structured to automatically be transferred into the child’s name at a pre-determined age. This is referred to as ‘child advancement’.
- Estate planning. Because an investment bond is in essence a life insurance policy, it is subject to life insurance rules. This includes the ability of the owner of the investment bond to nominate one or more beneficiaries to receive the proceeds of the bond in the event of the death of the bond owner. By nominating beneficiaries under an investment bond, the bond does not form part of the estate of the bond owner and may be administered separately to their estate.
- Deceased estates that are required to invest bequests that will vest with beneficiaries at a later date.
There three parties to an investment bond; the owner – who subscribes the investment funds, the life insured – who may be the bond owner, or someone else, and the issuer of the bond – the life insurance company.
Some bonds may include fourth party, being a nominated beneficiary. The bond owner may nominate a beneficiary to receive the bond proceeds in the event of the death of the life insured.
Where a bond is issued on the life of a child, and its ownership is to vest in the name of the child at a future date, the bond is subject to Child Advancement Conditions. The owner of the bond may nominate an age, up to 25, at which the ownership of the bond will transfer to the child.
Insurance bonds are tax paid investments. This means earnings on the investment are taxed in the hands of the life insurance company at the corporate tax rate. Insurance companies are generally taxed at a rate of 30% however the actual rate of tax payable may be less than 30% when tax deductions, tax offsets, and tax credits available to the life insurer are taken into account.
Investment bonds can be tax effective for long term investors with a marginal tax rate higher than 30%. An investment bond is designed to be held for at least 10 years. If you hold the bond for at least 10 years, the returns on the investment, including additional contributions that meet the 125% rule, will be tax free. In some circumstances, investing in an investment bond for a shorter period may be an appropriate strategy.
If you withdraw money before 10 years is up, some or all of the income will be taxable and included in the investor’s assessable income. This amount is taxed at the investor’s marginal tax rate – however a 30% tax offset is allowed to compensate for the tax already paid by the life insurance company. Where an investor’s personal tax rate is less than 30%, any unused portion of the tax offset can be used to reduce tax payable on other income in the same financial year.
If you make a withdrawal within the first 10 years, the rate at which earnings in the investment bond are taxed will depend on when you make the withdrawal.
Tax treatment of investment bond withdrawals
Year withdrawal made | Tax Treatment |
Within 8 years | 100% of the earnings on the investment bond are included in the investor’s assessable income and a 30% tax offset applies. |
In the 9th year | 2/3 of earnings on the investment are included in the investor’s assessable income and a 30% tax offset applies. |
In the 10th year | 1/3 of earnings on the investment are included in the investor’s assessable income and a 30% tax offset applies. |
After the 10th year | All earnings on the investment are tax free and do not need to be included in the investor’s assessable income. |
The investment earnings are calculated by referencing a formula contained in the Australian Taxation Office’s Income Tax Ruling 2346.
While investment bonds are often described as a ‘single premium’ or lump sum investment, many investment bonds accept both regular and irregular additional investments. Provided the amount invested in any one year – based on the anniversary of the bond commencing – does not exceed the previous year’s investment by more than 125%, it will be considered part of the initial investment.
If you exceed 125% of the previous years’ investment, the 10 year period will reset. If you do not make a contribution in any one year, a contribution in following years will reset the 10-year rule.
The life office issuing the investment bond may offer a range of investment options such as single asset funds i.e. cash, fixed interest, shares, property or a range of diversified options. Each option has different investment goals, timeframes, risk profiles and underlying assets.
The key risks are largely determined by the nature of the investment chosen. Risks to be aware of include:
- Market risk: The performance of the investment bond will be affected by the assets and securities that it invests into.
Fees: These may vary depending on the investment bond and investment options chosen and include management and administration fees and buy-sell spreads.