‘Women & Investing part 3’ by Bill Dodd published in Great Health Guide (Nov 2015). Always wanted to know how to invest but find it daunting with all the information out there? Join us on this great series about women & investing. In part three of this series, Bill explains why we should invest in the share market.
Read other Finance articles on Great Health Guide, a hub of expert-inspired resources empowering busy women to embody health beyond image … purpose beyond measure.
FINANCE: Women & Investing Part 3
written by Bill Dodd
This is the third in a series which discusses investing for women. This article considers why and how to invest in the share market.
1. What are shares?
Of the different asset classes available to investors, shares are the most popular and widely held investment. Most Australians will have at least an indirect investment in shares through their superannuation fund. A share entitles an investor to a part ownership in a company. As a shareholder in the business of that company, the investor is entitled to shareholder benefits, including dividends. While the terms ‘shares’ or ‘stocks’ do have different meanings they tend to be used interchangeably. Shares are bought and sold on an electronic open market through the Australian Securities Exchange and this provides investors with the opportunity to quickly and easily buy or sell shares. Participants in the stock market range from small individual investors to large managed funds. In the Australia stock market activity is dominated by managed funds and institutional investors.
There are about 2000 companies listed on the Australian stock market and they are divided into sectors such as energy, industrials and health care. The major market index (the ASX200) is made up of the top 200 stocks. The ASX200 is regarded as the most important index because it serves as the benchmark for fund managers. The other perhaps more widely known index, the All Ordinaries Index, comprises the top 500 stocks by capitalisation.
2. Why invest in shares?
While this article is about investing in the share market, any investment portfolio should be diversified and may include other asset classes such as real estate, fixed interest and bonds. Of the different asset classes, shares are favoured as an investment because they are liquid and may be sold very readily. But more importantly, shares have outperformed other asset classes, including real estate, over the very long term, with international shares sometimes outperforming Australian shares.
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Shares are a very attractive investment because they are very liquid, meaning that there is always a market to buy and sell your shares. By comparison, while it may take three or more months to complete the sale of property, shares can be sold on the market immediately and the funds are transferred to the investor’s account within three days. Shares also offer the opportunity to diversify investments over a broad range of different businesses and over international markets.
3. What types of shares to invest in?
There are about 2000 listed companies on the Australian Securities Exchange. In Australia the market is dominated by listed companies in the resource sector (includes mining and exploration) and the financial sector (includes banks and insurance). It is important to select the companies that you invest in very carefully because a large number, particularly those in the resource sector are speculative exploration companies which do not pay dividends. While a few of these resource companies may eventually become a BHP of the future, many will never pay a dividend, will exhaust their capital and will eventually be delisted from the stock exchange. So it is important to avoid such speculative companies particularly when you are starting as an investor. It would be safer to concentrate on those companies which have solid growth, reliably pay a dividend and there is some confidence that they will still be in business in ten years’ time. Such large, well established companies are termed blue chips. The investment article in the next issue of Great Health GuideTM will discuss how to select shares for the portfolio.
4. Different ways to invest
When investing in shares there are a number of ways to go about it. Shares can be owned personally and this is called direct investing. Alternatively an investor could choose to buy units in a managed fund. In this situation, it is the professional fund manager who buys the shares and manages them on behalf of the investor. Yet another way in to buy shares is through a listed investment company (LIC). The LIC is a company listed on the stock exchange which invests in other listed companies. There are many different LICs investing in a broad range of different listed companies. Using an LIC is a simple way to invest in a diversified portfolio and is a very useful approach to investing when starting with limited capital.
5. Risk, diversification and money management
Investors need to understand that there are risks associated with any investment and in general the higher the potential return, the higher the risk. This means that an attractive investment which offers a return of 20% per annum carries a much higher risk than a blue chip share which may only pay a dividend of 5%. There are many different types of risks which include:
Market risk: the risk that the market will fall and most shares will fall in value too. This risk can be minimised by avoiding investing a large amount of money in the share market at any one time. This spreads your investing over time and you will avoid investing all the capital in a falling market.
Specific risk: the risk that a specific share that you invest in will fail due to company problems, such as bankruptcy. The way to minimise this risk is to diversify and make sure that you invest in a number of companies in different sectors.
Inflation risk: Inflation is a general increase in prices and a fall in the purchasing value of money. This is a problem for all investors and particularly for retirees who are depending on returns from investments. Avoid the problems of inflation by investing in assets such as shares or property which should increase in value at a rate equal to or greater than the rate of inflation.
It is surprising how often one hears stories about investors who have put all of their assets into one investment and suffered significant losses. Such devastating losses can be avoided by spreading the risk over many companies. It is most important to diversify the investments across different companies and different asset classes. This is the most obvious way that investors can protect themselves from different risks. It is also necessary to use money management whereby no more than 2% of the investment capital is risked on any single investment.
6. The Investment Plan
One of the reasons why so many investors fail is that they do not have a written investment plan. The investment plan is basic to successful investing. It provides a guide as to what to buy and sell and how to manage risk. It protects the investor during periods of market instability. It is worth remembering that the investment plan is something that is unique to any one investor and it will evolve over time. The following is a list of variables which an investors should include in an investment plan.
Strategy: is this a buy and hold for long term portfolio?
Asset classes: what percentage will be in Australian or international shares or cash?
Market entry: when will you buy the shares?
Market exit: why, how and when will you sell the shares?
Risk management: diversification – how many companies will you invest in?
Type of stocks: will you invest only in blue chip shares that pay a dividend?