Investment Strategies
You inherit $50,000. Should you put it in a savings account at 4%, buy shares expected to return 8%, pay down your mortgage at 5%, or split it across all three? There is no single right answer — the best choice depends on your goals, time horizon, risk tolerance, and the broader economic environment. Investment strategy is the art and science of allocating money across different options to achieve the best risk-adjusted return.
Practise this lesson
Three printable worksheets that build from foundations to mastery — or build your own from any module’s questions.
You have $10,000. Option A: term deposit at 4.5% guaranteed. Option B: shares with expected 8% return but possible loss. Option C: extra mortgage repayment at 5.2%. How would you decide? What information do you need?
Before reading on — write your gut reasoning. We will revisit this at the end of the lesson.
Investment decisions are driven by four factors: return, risk, time horizon, and the impact of inflation. Two ideas tie almost every comparison together.
Real return: $\text{Real return} = \text{Nominal return} - \text{Inflation rate}$. This is what your money's purchasing power actually grows by — not just the headline number on the statement.
Risk-return trade-off: Higher potential returns always require accepting higher risk. There is no free lunch in investing — if an option seems to offer high returns with no risk, re-examine the assumptions.
Key facts
- The risk-return relationship
- The diversification principle
- Real return vs nominal return
Concepts
- Why time horizon matters for investment choice
- How inflation erodes purchasing power
- The trade-off between liquidity and return
Skills
- Calculate nominal and real future values
- Compare multiple investment options quantitatively
- Assess risk-adjusted choices for different scenarios
When comparing investments, you must consider all of these dimensions — not just the headline rate:
- Expected return: The average annual growth rate
- Risk/volatility: How much returns vary year to year
- Liquidity: How quickly you can access your money
- Time horizon: How long until you need the money
- Tax implications: Interest, dividends, capital gains taxed differently
- Inflation: The real purchasing power of returns
Real return formula:
$$\text{Real return} = \text{Nominal return} - \text{Inflation rate}$$Examples:
- 6% nominal return with 3% inflation $\Rightarrow$ 3% real return
- 4.5% term deposit with 2.5% inflation $\Rightarrow$ 2% real return
- 7.5% shares with 2.5% inflation $\Rightarrow$ 5% real return
What to write in your book
- Real return = Nominal return − Inflation rate.
- Compare all 6 dimensions: return, risk, liquidity, time horizon, tax, inflation.
- Mortgage repayment = guaranteed risk-free return equal to the mortgage interest rate.
Quick check: A term deposit earns 5.5% p.a. When inflation is 2.8%, the real return is:
The risk-return spectrum:
| Investment | Typical return | Risk level | Liquidity |
|---|---|---|---|
| Savings account | 2–4% | Very low | Very high |
| Term deposits | 4–5% | Low | Low (locked) |
| Bonds | 4–6% | Low-medium | Medium |
| Property | 5–8% | Medium | Very low |
| Shares (ETF) | 7–10% | Medium-high | High |
| Cryptocurrency | Highly variable | Very high | High |
Diversification: A portfolio of 100% shares might return 8% on average but could lose 30% in a bad year. A diversified portfolio (50% shares, 30% bonds, 20% property) might return 6.5% on average but only lose 12% in a bad year. The diversified portfolio sacrifices some return for significantly less risk.
Time horizon:
- Short term (0–3 years): Safety first — savings accounts, term deposits
- Medium term (3–10 years): Balanced — mix of bonds and shares
- Long term (10+ years): Growth-focused — mostly shares and property
What to write in your book
- Higher return always means higher risk — there is no free lunch.
- Diversification: spreading across asset classes reduces risk more than return.
- Short term (<3 yr) = safe assets. Medium (3–10 yr) = balanced. Long term (>10 yr) = growth.
True or false: A risk-averse investor with a 25-year time horizon should always choose a term deposit over shares, because term deposits are safer.
Worked examples · reveal each step
$20,000 to invest. Option A: 4.5% term deposit. Option B: diversified shares expected to return 7.5% but with possible 20% loss in any year. Inflation = 2.5%. Time horizon = 8 years. Calculate real returns and expected final values. Make a recommendation.
A 25-year-old contributes $500/month to super (plus $575/month employer at 7.2% p.a.). As an alternative, they invest $270/month after-tax (32.5% marginal rate) in an ETF at 8% p.a. Compare balances at age 65.
How to compare investments systematically:
- Calculate the nominal future value for each option: $FV = PV(1+r)^n$ for lump sums, or $FV = PMT \times \dfrac{(1+r)^n - 1}{r}$ for regular contributions.
- Calculate the real future value: use the real return rate instead of the nominal rate.
- Consider the worst-case scenario for risky assets.
- Factor in liquidity, tax, and access restrictions.
- Match to the investor's time horizon and risk tolerance.
What to write in your book
- Lump sum FV: $FV = PV(1+r)^n$. Regular contributions: $FV = PMT \times \frac{(1+r)^n-1}{r}$.
- Use real return rate for purchasing power comparisons.
- Always consider: liquidity, tax, time horizon, worst-case scenario.
Fill the gap: A 6% nominal return with 2.5% inflation gives a real return of %. After 10 years, $30,000 invested at 6% p.a. gives a nominal future value of $ (round to nearest dollar).
Common errors · the 3 traps that cost marks
What to write in your book
- For purchasing power: compare real returns, not nominal rates.
- Assess risk relative to the investment time horizon — short-term volatility is less relevant for long horizons.
- Diversification reduces risk more than proportionally because assets are not perfectly correlated.
Match each term to its correct description:
Quick-fire practice · 2 activities
Calculate real returns for: (a) 3.5% savings with 2% inflation, (b) 7% shares with 2.5% inflation, (c) 5% property with 3% inflation. Then find the nominal FV of $30,000 invested for 10 years at (a) 6% and (b) 4%.
A retiree has $500,000. Why should they NOT put it all in shares despite higher expected returns? A 25-year-old with $500,000 — should they make the same decision? Explain using time horizon and risk tolerance.
Top 3 list: Name THREE factors (beyond the nominal interest rate) that should influence an investment decision. For each, explain with a concrete example how it affects the choice.
The decision depends critically on time horizon and risk tolerance. The term deposit (4.5%) is safe but barely beats inflation. The mortgage repayment (5.2%) is a guaranteed 5.2% return with no tax — excellent if you value certainty. Shares (8% expected) offer the highest long-term real return but with volatility.
For money needed within 3 years: term deposit or mortgage is safer. For money not needed for 10+ years: shares historically outperform. Many advisors recommend splitting — some in safe assets for short-term needs, some in growth assets for long-term wealth building.
What has changed in your understanding? What did you get right? What surprised you?
Pick your answer, then rate your confidence — that tells the system what to drill next.
Q1. An investment earns 7.5% p.a. nominal return. With inflation at 3%, the real return is:
Q2. Paying an extra $5000 on a mortgage charging 5.4% p.a. is mathematically equivalent to:
Q3. A retiree needs income from their savings in the next 2 years. The most appropriate investment is:
Q4. A diversified portfolio holds 50% shares, 30% bonds, and 20% property. Compared to 100% shares, the diversified portfolio will typically have:
Q5. $25,000 invested for 6 years at 5% p.a. compounded annually. The future value is closest to:
SA 1. (a) Calculate the real return on a 5.5% term deposit when inflation is 2.8%. (b) $25,000 invested for 6 years: compare a term deposit at 5% (guaranteed) vs shares at expected 8% (with possible 25% loss in year 1). Find the final values for both the best-case and worst-case share scenario. (c) Which would you choose for a 6-year time horizon, and why? (2 marks)
SA 2. A couple has $40,000. They can: (A) pay down their mortgage at 5.4%, (B) invest in super at expected 7% (taxed at 15%), or (C) put in a savings account at 4%. Inflation is 2.5%. Compare the after-inflation, after-tax outcomes over 10 years and recommend. (2 marks)
SA 3. A 25-year-old earns $60,000 and contributes $500/month to super. Their employer contributes $575/month. The super fund earns 7.2% p.a. compounded monthly. (a) Calculate the super balance at age 65. (b) As an alternative, the person invests $400/month (after tax at 32.5%) in an ETF at 8% p.a. compounded monthly. Calculate the balance at age 65. (c) Compare both options on return, liquidity, and risk. Make a recommendation, noting one limitation of your answer. (3 marks)
Comprehensive answers (click to reveal)
MC 1 — C: Real return = 7.5% − 3% = 4.5%.
MC 2 — B: Extra mortgage repayment saves interest at the mortgage rate — a guaranteed, risk-free return of 5.4%.
MC 3 — D: Short time horizon and need for liquidity require a low-risk, accessible investment.
MC 4 — A: Diversification reduces both return and risk compared to 100% shares, but reduces risk more than proportionally.
MC 5 — C: $25\,000 \times (1.05)^6 = 25\,000 \times 1.3401 = \$33\,503$.
SA 1 (2 marks): (a) 2.7% [0.5]. (b) TD = $33,503; Shares best = $39,698; Shares worst = $25,000 × 0.75 × (1.08)5 = $29,773 [1]. (c) Reasoned recommendation based on risk tolerance and time horizon [0.5].
SA 2 (2 marks): (A) Mortgage FV equivalent = 40,000 × (1.054)10 = $67,700, real return 2.9% [0.5]. (B) Super after tax: 7% × 0.85 = 5.95%, real = 3.45%, FV = $70,200 [0.5]. (C) Savings real 1.5%, FV = $59,210 [0.5]. Recommendation: Super has highest after-tax real return; mortgage is guaranteed [0.5].
SA 3 (3 marks): (a) $1075/month, r=0.006, n=480. FV = $1,075 × [(1.006)480−1]/0.006 ≈ $2,819,700 [1]. (b) After-tax amount = $400 × 0.675 = $270/month. After-tax return = 8% × 0.675 = 5.4% p.a. = 0.45%/month. FV = $270 × [(1.0045)480−1]/0.0045 ≈ $519,500 [1]. (c) Super dominates mathematically ($2.8M vs $520K) but is inaccessible until preservation age (~60). ETF is accessible anytime but produces far less due to tax. Recommendation: prioritise super, but maintain some liquid investments. Limitation: assumes rates remain constant over 40 years, which is unlikely [1].
Drill 1: Real: (a) 1.5%, (b) 4.5%, (c) 2%. FV at 6%: $53,725. FV at 4%: $44,407.
Drill 2: Retiree needs income soon — high volatility risk with no time to recover losses; needs liquidity. 25-year-old can absorb losses over decades; shares are appropriate for long-term wealth building.
Five timed questions on real returns, risk-return trade-offs, diversification, time horizons, and future value calculations. Beat the boss to bank a tier — gold (90% + speed), silver (75%), or bronze (50%). Replays welcome.
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