Personal finance guru Noel Whittaker has updated his book, Making Money Made Simple. He shares this extract with YourLifeChoices members.
“A lean purse is easier to cure than to endure.” George S. Clason
There is great value in investing in shares, but it raises a major question: where do you start? You need to decide whether you want to do it yourself, use a managed fund, such as an equity trust, or take the easy way out and use an index fund, which simply replicates a specific large index, such as the All Ordinaries.
I have been investing in shares since I was 19, and have had plenty of winners and losers, but the older I get, the more I am convinced the easiest and safest way to invest in Australian shares is through an index fund. But whenever I use the term, either in newspaper columns, or when speaking at seminars, it is evident that most people don’t understand it. So, here’s a simple explanation.
Index means a measure of value. The consumer price index measures the cost of goods; the happiness index measures how happy the citizens of a country are, based on certain criteria. And a stock exchange index measures the value of a stock exchange. There are many stock exchanges around the world, and many indexes within those stock exchanges.
The indexes most used in Australia are the ASX 300 and the All Ordinaries. Their performance is roughly the same as each other because the bulk of the money invested in the ASX is in the ASX 300. The extra 200 or so companies included in the All Ords, are simply not that large a part of the market. The ASX 300 index is itself broken down into sub-indexes, such as Financials, Materials and Healthcare.
Financials and Materials account for roughly 60 per cent of the ASX 300, and the largest company in Australia – which at date of writing is BHP – accounts for nine per cent of the ASX 300.
The top 10 shares in the ASX 300 are worth more than the bottom 277 combined.
Exchange traded funds (ETFs) are funds that trade on a stock exchange, just like ordinary shares. They combine the investment advantages of a managed fund with the ease and cost-effectiveness of share trading.
You can use ETFs for cost-effective, easy access to markets and asset classes you might not otherwise have access to, such as debt, derivatives, currency and commodities.
Two index funds I use myself are:
- SPDR S&P/ASX 200 ETF (STW) and the
- Vanguard Australian Shares Index ETF (VAS).
If you want to add a bit of spice to your life, you could go the other route, and have a go at picking shares yourself. As somebody who has been trying to do this for many years, I can assure you it’s much harder than it seems. For starters, the key to being successful is to find an undervalued share, which is hard to do given the wealth of information available. Most of the weekend papers publish brokers’ tips; if you choose a stockbroker they will make recommendations for you, or you could subscribe to blogs, magazines or newsletters that specifically focus on finding value in the share market. As far as I’m concerned, it’s all too difficult, and way beyond the scope of this book. But best of luck, if that is the way you want to invest.
I believe that picking individual shares is too risky for the average individual, and most people would do better to use an index fund. The sum of $20,000 in January 1980 invested into an index fund that tracked the All Ordinaries Accumulation Index, which includes income and growth, would have been worth $1,157,600 (calculated using the Stock Exchange Calculator at www.noelwhittaker.com.au/mmms) at 30 June 2019. That’s a capital gain of 10.9% a year.
Look beyond Australia
So far, we have talked about Australian shares, but most countries in the world have stock exchanges, too, and you can readily buy and sell shares listed there. Our share market accounts for just under two per cent of global share market value, so you are missing 98 per cent of the investment opportunities available if you don’t consider other markets.
And it is not just the dollar value of the overseas markets – it is the diversification they offer. Australia does not have huge, specialised industries such as pharmaceutical companies, or massive computer companies, aircraft manufacturers or shipbuilders. Investing offshore lets you have a piece of their profit too. Unfortunately, dividends from foreign companies don’t carry franking credits, you pay full tax on them.
Also, overseas shares tend to give lower yields than local shares, so your dividend may be smaller in relation to the price you pay for the share. These companies will have to provide you with superior capital growth to compensate.
When investing in overseas markets, the value of the Australian dollar also affects your returns. If you invested $10,000 into American shares at a time when one Australian dollar was equal to 75 US cents, your $A10,000 investment would have bought you shares worth $US7500.
If the Australian dollar fell to 60 US cents, your $US7500 would be worth $12,500 in our dollars. You would have made a profit of 25 per cent just because of the currency movements.
Naturally the process also works in reverse: if our dollar strengthens against overseas currencies, the value of your shares will drop in Australian dollar terms.
How to buy internationally
You will find a host of reputable online broking houses that can buy international shares for you, as well as many free services providing prices and graphs so you can watch the shares in which you are interested. You can also buy overseas shares through most Australian stockbrokers. That’s fine in theory, but I don’t recommend it. The paperwork is overwhelming, and your accountant will hate doing your tax.
A much better, simpler way to have an international exposure is to invest in an Australian share trust that holds international shares. You can start with as little as $2000 and make regular investments of as little as $100 a month – this is not practical when buying shares direct.
Dollar cost averaging
Dollar cost averaging is a strategy to smooth out volatility. You simply invest the same dollar amount into shares each month, no matter what. When the market is performing strongly, your portfolio will be doing well, and when the market is weak, you can buy more shares at a cheaper price. Over time, you will have a lot more money working for you than you would have if you bought irregularly.
There is a dollar cost averaging calculator in the online resources, which you can use to calculate hypothetical scenarios and get inspired about this method of investing.
- quality shares and index funds should significantly outperform bank interest over the long term
- diversify by including international shares in your portfolio, preferably using managed funds
- regular investments into the share market (dollar cost averaging) is a sound strategy for many investors
- don’t keep all your money in a savings account. Do your research and put it to work.
Making Money Made Simple, by Noel Whittaker, is available from all good bookshops.
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Disclaimer: All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.