Investing can be pretty tricky, right? You want to make sure your money is safe, but you also want to earn a decent return. As a first-time investor, it's normal to feel anxious about losing your hard-earned cash because of a wrong decision. You might even think of throwing your money into a safe, low-interest account. But that's not going to help you build wealth over the long term.
So, you've got a big decision to make: which type of investment should you put your money into? Don’t worry, we've got you covered. In this article, we'll break down the difference between defensive and growth investments and help you pick the one that's right for you. That way, you're one step closer to crushing your financial goals.
The difference between defensive and growth investments
There are these two types of investment strategies: defensive investments and growth investments. Which one you choose depends on your financial goals, risk tolerance, and investment aims.
1. Defensive investments — the advantages and disadvantages
Defensive investments are assets that are lower in risk. They're designed to provide stable returns and protect your capital against market fluctuations. This type of investment can also give you a regular flow of cash. For example, bonds and some types of managed funds can provide investors with regular interest or dividends. These then can be a good source of passive income.
So here's the deal with defensive investments: they might not give you high returns, unlike growth assets (which we'll get to soon). A downside to this type of investment is that it might not have the same chance for huge returns. Plus, your defensive investment might not be able to keep up if inflation starts to pick up. If this happens, your purchasing power could take a hit over time.
2. Growth investments — the advantages and disadvantages
Meanwhile, growth investments are assets that could grow in value over time. They might be riskier because market changes can affect their value, but they could also give higher returns over time. So, if you think you can take more risks, growth investments might be worth considering. Especially when they can help beat inflation because their value may increase faster than inflation.
By now we all know that one disadvantage of growth investments is that they can be pretty volatile. If the market goes south, your growth investments might take a hit and lose value. This can be super stressful, especially if you're not too keen on taking risks. Another downside is that they may need a longer time to see significant growth in value.
Defensive or growth investments - which one should I choose?
So, which should you choose? It all depends on your financial goals and how much risk you're willing to take on. If you're young, you're more likely to have a lot of time ahead of you to invest. If you want to take more risks, you can try a strategy with more shares and property.
But if you have a lower risk tolerance, you might want to consider a strategy that is more defensive. This means you could put more of your money into bonds and cash, which could protect you against sudden changes in the market. However, you might not make as much money as you would if you took on more risk.
There are a range of different ways to invest and spread your money around. It depends on what you want to do and how much risk you're comfortable with. Some people prefer to balance their investments with a mix of growth and defensive assets, while others choose to focus on specific areas. It's important to do your research and choose something that aligns with your goals and risk tolerance.
- Conservative strategy: This strategy is for investors who want to keep their money safe and aren't looking to take big risks. A conservative portfolio might be full of safe bets like bonds and cash, with a little bit of growth assets thrown in for long-term potential.
- Balanced strategy: This strategy is for investors who want to balance risk and reward. A balanced portfolio might have a split of 50% growth and 50% defensive assets.
- Growth strategy: This strategy is for investors who want to take on more risk to earn higher returns by managing their growth assets, such as shares. A growth portfolio might also have a small amount of defensive assets for diversification.
- Income strategy: This strategy is for investors who want to generate income from their investments. An income portfolio could have assets that provide regular income, such as bonds and dividend-paying shares. Investors can profit from dividends when they sell their shares at a higher price (also known as capital gains). Another option is to reinvest your dividends to enjoy the perks of maximizing compound interest
- Aggressive strategy: This strategy is for investors who can handle high risk and want to get the highest possible returns. An aggressive portfolio might have growth assets like shares, with little or no defensive assets.
Defensive investment case studies
Here we have Augustus, a cautious investor who wants to lock in a guaranteed return on his money. He decides to invest $20,000 in a term deposit with his bank, which offers a fixed interest rate of 2.2% over a two-year term. At the end of the term, Augustus earns $880 in interest, and his initial investment is returned to him in full. This investment offers a solid return without any risk to his principal.
A term deposit is like parking your money with a financial institution for a fixed period of time, which usually ranges from a few months to a few years. Augustus' money earns interest at a fixed rate, and he gets his initial investment back at the end of the term. This investment is safe because it protects your initial investment and guarantees a return.
Meanwhile, Rosario is a risk-averse investor. She decides to invest $5,000 in a bond fund that offers a mix of corporate and government bonds. The bond fund offers an annual return of 4%, and Rosario earns $200 in interest over the course of a year. The bond fund is divided among many different bonds to reduce the risk of any individual bond failing.
Bonds are loans that you give to a company or government. When Rosario invests in a bond, she’s lending them money, and they give her some cash back in the form of interest. Rosario gets paid interest on a regular basis until the bond is over, and then she gets her original investment back. Plus, bonds provide Rosario a steady stream of passive income through regular interest payments.
Growth investment case studies
To convey these concepts, we've created a few case studies below. Whilst they're loosely based on past market performance, the numbers in these case studies are all purely hypothetical.
Firstly, we also have Sophie, a risk-taker who wants to try her luck in shares. She decides to invest $5,000 in shares of a tech company that she's been keeping an eye on. Over the course of a year, the company's shares increase by 8%, and Sophie's investment is now worth $5,400.
Shares represent ownership in a company. When Sophie invests in shares, she is buying a piece of the ownership. Shares are growth investments because they could increase in value over time. Although short term market changes can be risky, historically, these investments have provided higher returns over time than other types.
Lastly, Deng is a savvy investor who wants to diversify his portfolio. He decides to invest $15,000 in a real estate investment trust (REIT) that specialises in commercial properties. Over the course of three years, the value of the REIT's shares grows by 25%, and Deng’s investment is now worth $18,750.
REITs are like a group investment where your money goes towards buying and managing properties. With REIT, Deng earns more money than if he were to choose a less risky investment. This is because the properties that the trust owns might become more valuable in the future. Another cool thing is that REITs can spread the risk by owning different types of properties in different places.
An overview of investing horizons
When it comes to investing, it's essential to know your investing horizon. This is the length of time you plan to hold onto your investments before you need to use the money for something else. The investing horizon can be short term (up to three years), medium term (three to 10 years), or long term (over 10 years). The length of your horizon will determine what types of investments are suitable for you.
A compound interest calculator can help you determine your investing horizon. This tool helps you figure out how much money you'll have if you invest some money at a certain interest rate for a certain amount of time. You can try different values to see how much your money will grow in different time periods.
Knowing your investing horizon is important because it will help you choose investments that match your goals. Short term investors may want to choose low-risk investments like bonds, while long term investors might prefer higher risk, high return investments like shares or REITs. So, take some time to determine your investing horizon and make sure you're investing in a way that matches your goals.
Congratulations! You now understand the difference between growth and defensive investment. Next, you can make smart choices about where to invest your money. It's important to keep in mind that every investment strategy has both risks and rewards, so research before making any decisions. And keep in mind: investing is a marathon, not a sprint. Keep your eye on the prize, and adjust your approach as you go.
Happy investing!
PS: Do you want to learn more about defensive and growth investments? In his new book Replace Your Salary by Investing, award-winning financial advisor Ben Nash explores these concepts and many more. Order your copy today!
