Carrot #1: Sharemarket returns have historically been higher than the other major asset classes
Over the last 20 years, Australian shares returned about 9% yearly, on average (a.k.a equities). This compares to 7% for residential property 🏡, to 7% for bonds + 3% for cash (not cash under your mattress, think term deposits). NB: historical performance isn’t necessarily an indicator of the future.
The % differences may not seem large, but over 20 years…?
$10,000 invested in shares would have grown to $56,000.
That’s compared to $19,500 if you’d left it in a cash management account with the big 5 banks (RBA). Another example of the magic of compounding!
Carrot #2: Share investment is appropriate if you can put the money away for a long period of time. Think years, not weeks 🕰.
The flipside to these returns is you take on more risk. The worst 12-month return in the last 20 years was -42%, while the best was +86%.
So although the returns from shares are higher, you need to buckle in!
Having said that, if you looked at any five year period of the last 20 years, you would have only been in negative territory for less than 5% of all months:
Carrot #3: Your returns are made up of dividends + capital gains (or losses). The bulk tends to come from capital gains.
Buying a share gives you partial ownership in a company, like Woollies or Telstra. So it gives you a claim on the company’s profits.
Unlike a term deposit where you know exactly how much you’ll get paid, what you’ll get for owning a share varies. There are two sources of returns:
- Dividend: the portion of company profits paid to shareholders
- Capital gain or loss: the difference between the price you pay vs. the price you sell for.
Carrot #4: It’s strongly recommended that you diversify and don’t put all your carrots in one stock.
Stock prices go up and down all the time. A key reason is how other investors (‘the market’) view the prospects of that company. This can change a lot, based on how the company is going plus the sentiment of the market (investors are people too, so they get skittish/optimistic like the rest of us) 😳😁.
It’s possible for the value of a stock to go to zero, meaning investors can lose the lot. But it’s also possible for a stock to go up in value by many times what you paid. So diversification is important!
Carrot #5: Outsourcing via fund managers or ETFs is probably less risky (+ less time-consuming) than D.I.Y. where you pick + trade individual stocks.
Buying + selling shares yourself requires a bit of work setting up, but after that it’s fairly simple. You can start an online broking account through your bank + place an ‘order’ for shares to be bought or sold… for about $30 a go. You can also go through a broker or financial advisor, but it’ll be more expensive.
Baskets of shares (portfolios) 🗑
Spending time researching + managing your individual stocks can be highly complex + time consuming. So there are two main alternatives:
- Fund managers offer lots of different products focusing on different investments. E.g. small companies, Australian shares or international shares. They invest your money according to certain rules, aiming to beat a pre-defined benchmark like the ASX200. A key benefit is that you have a ready-made diversified portfolio all in one package. This is known as ‘active’ investment.
- Exchange Traded Funds (ETFs) are increasingly popular. They’re listed funds that don’t try to beat a benchmark, but perform in line with it by holding a similar basket of assets. Fees are much lower, usually 0.2% to 0.4%. You buy or sell ETFs the same way you do individual shares, through an advisor, broker, or online. This is known as ‘passive’ investment.
These options will typically be less risky because the manager takes care of diversification. But it’s still important to have a long-term horizon as volatility remains high.
Make sure you read the small print📄 in the product disclosure statement. It’ll tell you what kind of stuff you’re investing in, plus risks, fees + how to get your money out. Fees can make a big difference 💰.
One of the biggest mistakes that all investors make (including professionals) is getting too caught up in short-term sentiment.
Carrot#6: Shares are a long-term investment!
So, it’s really important to resist piling into the market when things have been going up for a while and it seems like everyone is making easy money.
It’s conversely important to avoid panic by selling at the bottom when the outlook is terrible. Investing in shares is a great way to build long-term wealth, if you keep that in mind.
David Boyle is a Portfolio Manager + Partner at Rockman Capital, an absolute return small companies fund. Previously David worked at large fund managers for 10 years + is a CFA charter holder 🤓.
Thanks David! Stay tuned for next week’s Carrot, where we’ll be dishing on bonds, another important pillar for investing.
NB: This article is for informative purposes only, it is not to be taken as individual financial advice.