Learn about Australian shares and why it is an asset class more suited to longer-term investors or those with higher risk tolerances….

Asset allocation is one of the most important decisions you can make as an investor.

How you divide your portfolio between asset classes (whether between shares, fixed income, property and cash) will have the biggest effect on how your portfolio will perform and the returns it generates.

Finding the right mix of asset types is important because if you start with the right asset allocation, you'll also have more control over how risky your portfolio is.

To help you determine which asset classes are right for you, below is an introduction to shares; an asset class that is usually more suited to longer-term investors or those with higher risk tolerances.

Risk/return characteristics of shares

Shares are generally considered a high-risk and high-return investment.

Historically, Australian shares have provided long-term growth well above inflation. However, shorter-term sharemarket returns have experienced higher volatility at times. Time greatly reduces, but does not eliminate, the volatility in returns from shares, which is why this asset class is suitable for longer-term investors who have time to ride out any market swings.

Sharemarkets move in cycles, reflecting the underlying strength of the economy, political factors, industry trends and market sentiment. On any given day, interest rate and inflation expectations, company profits, dividends, economic growth figures and the rise or fall of our dollar may have an impact on share prices.

Income and capital growth

While shares are primarily a growth asset, they may also provide a good source of income.

Most companies distribute a proportion of their profits in the form of dividends. Companies that pay high dividends tend to be blue chip companies like those in the banking, insurance and retail sectors. Some companies, like those in the mining sector or newer industries like biotechnology, may retain dividends to fund future research, expansion or exploration.

Actual yields may change dramatically from year to year and vary from company to company. If company profits are not growing, dividends are likely to be stable and if profits fall, a company may have to reduce dividends.

Tax benefits

Dividend imputation helps Australian shares be tax effective. Given companies have already paid tax at the company tax rate, investors can use franking credits to offset the amount of tax they pay on dividends and have any excess credits refunded. The higher the franking level the greater the benefit.

Some companies pay fully franked dividends, with the maximum imputation credit of 30 per cent (equal to the company tax rate). Other companies pay partially franked dividends where the imputation credit will vary depending on the amount of tax they have paid on their profits.

Implementing your portfolio

You can invest in the sharemarket directly or through investment vehicles such as index funds, exchange-traded funds (ETFs) or actively managed funds.

Index-tracking managed funds and ETFs invest in all or a representation of shares in a selected index with the aim of producing index returns, before fees.

For beginner investors, index funds or ETFs may be an easy, cost-effective way to enter the share market because you don’t have to select individual companies yourself which research has shown to be difficult even for the most experienced of investors, and because they can provide instant diversification to help manage risk.

Vanguard Australia

Note: If in doubt, speak to your Financial Advisor/Planner, or call Westmount Financial/Rick Maggi (Perth)