Investment goals will differ for everyone, but one of the goals that many investors will set early in their investment journeys is to build a portfolio which will be able to return $1,000 in a month. The obvious question is of course “Well, what do I need to invest in order to make $1,000 a month?”
There is of course one right answer, but a good starting point, at least in theory, is to look at what the long-term average return of the stock market is. Over a long period of time, the Australian equity market is said to return on average 8% per annum. In theory, this implies that in order to make $1,000 per month, or $12,000 in a year, an investment of $150,000 returning 8% is needed. However, before putting the numbers to action, it is important to recognise the volatile nature of the market and the complications of overreliance on historical long-term averages.
Volatility is the movement of the price of stocks in the market due to shifts in demand and supply over a certain period. Whilst volatility in the market is mostly referenced to sudden falls, they also actually refer to rapid price increases. During periods of uncertainty and information asymmetry, there is higher volatility, while a stable and low volatile market is indicative of a more informed market. Volatility can be concerning but it is important to recognise that it is a normal part of investing. As it is unavoidable, it is important to account for market volatility and understand what causes these fluctuations before making important investment decisions. It is important to account for the risk of downturns while positioning your investments to capture positive movements. Factors that cause volatility in the market include political and economic factors, industrial-based factors as well as overperformance or underperformance of influential companies. These factors are important as they can affect future performance and change forecasted variables. In periods of high volatility, inexperience and unfamiliarity with the market can lead to significant losses, though also presents significant opportunity for those who have the experience to take advantage of the market conditions. The volatile nature of the market signifies that a $150,000 investment may be insufficient or indeed, more than sufficient when it comes to making a $1,000 monthly return.
The goal of any investor would be to maximise returns for any given level of volatility, but different types of investors would treat volatility differently. For example, trader often profit off of heavy volatility, and may feel that minimising volatility would impact returns. Other investors, such as those who are coming close to retirement age, would rely more heavily on dividends and long-term capital gains, and more susceptible to market volatility - and are therefore more prone to minimise unfavourable movements within the market. To ensure a consistent return of $1,000 per month it is important to account for the volatile nature of the market and maintain a forward-looking perspective.
Portfolio diversification is a key strategy in ensuring investments volatility is reduced. Diversification is a technique where several types of investments assets and different financial instruments are purchased to protect and offset downturns. The key to the different assets has reduced volatility between the assets and therefore, that their responses to market events will be different. This comes down to the idea that when a substantial percentage of your investment is put into one specific industry or company, a negative market event will affect a major proportion of your investment resulting in significant losses. With different industries and companies in your portfolio, market movements that are detrimental to one industry may be advantageous to another industry in your portfolio, which allows negative movements to be offset. However, this effectively runs at risk of slow portfolio growth as similarly, a substantial return in one industry can be deemed as unfavourable for another industry in your portfolio. Nonetheless, diversification eventually tends to reward investors a steady return. In addition, it is important to realise that diversification can minimise risk but does not completely remove the risk of systematic market volatility.
The idea that a $150,000 capital requirement is sufficient to maintain a stable $1,000 monthly return is based on long-run historical returns. Different investment horizons should be considered as shorter investment horizons are not comparable to longer investment horizons as they have different rates of return. This draws on the fact that market conditions and economic conditions are constantly ebbing and flowing, changing the returns that can achieve in that period. Market conditions today are vastly different from conditions 10 years and even 1 year ago. Complete reliance on historical data is reasonable yet uninformative. Feasible investment amounts are more accurate when the future returns used are adjusted according to the current and expected future market movements as they are a more accurate expectation of future returns. For example, in a period where returns of 15% are forecast, the investment amount could be as little as $80,000 – but a portfolio of $300,000 would be needed if returns of only 4% are expected. This illustrates the need for an appropriate adjustment to your investment size based on information today rather than reliance on historical long-run averages. Thus, this draws on the need to be an informed market participant who considers future market expectations.
Defensive investments: Less risky investments that are focused on generating income rather than growth.
Growth investments: Riskier assets, with the increased risk made more attractive by the potential for higher returns. It is more suitable for investors who can manage a more volatile asset.
When building up your portfolio, you would also need to consider what companies you may want to invest in as there are can be high yielding companies where $100,000 initial capital can be sufficient to support a $1,000 monthly return or low dividend yield companies that may require up to 1.5m initial capital.
It should be noted though, that investing in companies purely based on their current dividend yield is not recommended – while it might serve as an indication of the dividend policy and subsequent future yields, changing market and business conditions could see the management team choose to alter their current dividend strategy, in order to either protect the company from future risks, or to reward shareholders in periods of strong performance.
Furthermore, while investing in high dividend yield stock can be beneficial due to the reduced amount of initial investment capital required, it is important to note that return is linked to risk. Return is often adjusted according to the risk exposure which means that a company is only willing to give investors higher returns when they are presented with more risks and when there are challenges present within the company. Lower-yielding stocks on the other hand have more stable returns and are less prone to risk exposures.
Lastly, it should be considered that companies typically only pay two dividends in a year (or four times, which is more common amongst REITs) – while this exercise has been based on annual averages anyway, relying on dividends to realise returns rather than capital growth would mean the required income to average $1,000 per month would only be paid in two months of the year, rather than spread out more evenly across the year.
To be an informed investor it is important to evaluate the appropriate amount of risk that you can afford to take. This can be conducted through investment professionals and advisors. Learn to rebalance your portfolio and update portfolios based on new market conditions to ensure that maximum advantages of market conditions are taken. Keep informed on state of the market and the individual assets that you have purchased or are planning to add to your portfolio to further diversify. Due diligence is highly recommended before making an investment decision to ensure that all factors have been considered.
Overall, $150,000 is reasonable guide for the size of the investment which is required to achieve a $1,000 monthly return but this is based on long-term averages and might not be valid in the short-term. The best guide as to how much would need to be invested to return $1,000 per month would be to view what you expect the returns for your theoretical portfolio to be based on your various target prices, and use that to adjust the actual size of your investment.
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