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The investment universe (for beginners) – Shares
Warning: the examples of shares in this post are for illustrative purposes only. They are not to be considered investment recommendations. I have no financial interest in any of the investments mentioned.
In the next few posts we will look at the different ways in which to invest your hard-earned savings, keeping in mind I wish to stick to basics.
We will take a journey through shares, exchange traded funds, managed funds and responsible investing, ending with the construction of a basic portfolio.
Nearly 100% of us will start from the ground up, meaning you will buy investments without much thought to the purpose of it and how it fits into the grand scheme of things, that is, your investment plan.
When I started in shares, I was really just playing around. Due to my line of work, I now have the big picture view of how to construct an investment portfolio.
Is an understanding of asset classes critical? No. Not at this stage. With regards to your super fund, professionals can manage it for you.
Is it helpful to have the big picture in mind before you start, even if it’s a vague concept? Absolutely.
Playing around with investing may end up a little more focused with a little more knowledge, and get you on track faster than just blindly picking shares to buy.
Mindset of investing
The right mindset for a successful investor:
- Have your investment goals in the front of your mind.
- Play the long game. True investing is a marathon not a series of sprints.
- Investing should not be exciting. Other areas of your life should be dedicated to excitement. Not this.
- Try not to get emotionally attached to a company, a managed fund provider, an industry or a country you are investing in. It’s just an investment. An investment is a tool. Do you get excited about a hammer, a ruler, a calculator or a computer screen? They are just tools to get the job done. Will you get emotional? Of course, just ensure it doesn’t cloud your judgement.
- Develop rules for investing. Examples include, only investing in things you understand, invest 30% of my income each month, when to sell a loser company, have a diversified portfolio. This may take time and involve some research and a bit of trial and error.
- Start small, especially if you are buying individual shares.
- Be realistic about returns. The 40-year average return for the Australian share market is 9.6%.
- Understand risk and return and how they apply to your goals. That is, don’t place your deposit for a home on the hottest speculative tech company.
Things to be aware of:
- Day trading. Arguably they are speculators/gamblers.
- Sources of advice. Bad advice can be the most costly of all advice.
- Hot tips. Usually, by the time the tip gets to you, the professionals took advantage of it last month. That means you buy in at the top.
- Selecting shares is really hard work to do right. If you have not put the work in, you are speculating.
- Don’t forget your goals.
- Always be learning. It could be about the economy, the country you wish to invest in, an asset class, people’s points of view.
- Investing is a mix of science and art. Why art? Because people are involved. People do get emotional (greed and fear especially). People interpret information differently. To buy something, means someone wants to sell it, which can mean these people have different points of view on the same thing.
- Staying the course (the big picture) is hard.
Let’s get investing …….
Shares
Owning shares in a company means that you are a part owner of the company. You are a shareholder. This does not mean that you can have you say about the day to day running of the company, but you can have voting rights to elect members of the board and to participate in the annual general meeting and ask questions about how the business is being run and the future of the business.
You may be part owner, but you aren’t the CEO!
What’s the point of owning shares?
To make money.
How?
- Capital Growth
- Dividends
Shares – Capital Growth
The aim of a business, obviously, is to make money (and solve a problem for consumers).
If investors think that the future of the company is good, over time the share price should rise. You experience capital growth by the increase in the value of the shares from when you purchased them. That’s how you increase your wealth.
Afterpay is a great example.
If you bought shares in 2017 for $2.95, your money has increased by 44 times. If you bought in early 2021 at $150, well that’s a different story. (As of January 2022 Afterpay is no longer on the ASX and its final share price was $66, a big fall from $150!).
Key point – you don’t actually have the gain until you sell. This is called a paper profit, or unrealised capital gain. You realise the gain (or loss) when you sell. When you make a gain, it will add to your income that is assessable by the tax office (always speak to your accountant regarding tax matters).
Or you could experience this …. Telstra.
If you bought in 2000, you have a capital loss.
If you bought in 2011, by 2015 you’ve roughly 2.5 x your money, but if you continued to hold you only have a minor gain.
And here is the example of a mad rush of excitement that turns horrible.
Zoono Group Ltd
A massive spike from $25 to over $150 and then back down just as fast.
Just remember, at $150 a person thought it was wise to sell and another wise to buy. From $150 to $0.58 is a 99.6% loss.
Then there are companies that go bankrupt. Loss is 100%.
This is the risk of owning direct shares.
This is also the importance of diversification.
A diversified shareholding would hold a range of shares across different sectors of the Australian economy. Maybe even different sized companies (large, mid-size, small caps).
The companies on the Australian Stock Exchange (ASX) are divided into 11 sectors, 24 industry groups, 69 industries and 158 sub-industries. I’ll just briefly show the 11 sectors (in no particular order).
| Sector | No. of companies | Examples |
| Energy | 144 | Woodside Petroleum |
| Materials | 723 | BHP, Fortescue Metals, Rio Tinto |
| Industrials | 155 | Transurban, Sydney Airport, Qantas |
| Consumer discretionary | 143 | Wesfarmers, Domino’s Pizza, Harvey Norman |
| Consumer Staples | 76 | Woolworths, Coles, Bega Cheese |
| Health Care | 183 | CSL, Cochlear, Ansell |
| Financials | 289 | Commonwealth Bank, Macquarie Group |
| Information Technology | 191 | Xero, Block |
| Communication Services | 79 | Telstra, TPG Telecom, Seek |
| Utilities | 24 | Origin Energy |
| Real Estate | 80 | Goodman Group |
Holding a diversified portfolio of direct shares will reduce the volatility of your portfolio. It will help the “sleep at night” factor.
Shares – Dividends
The other source of income from shares is dividends.
A dividend is a distribution of cash or shares to shareholders in a company. You invest in a company and may receive a portion of the profits.
Just know that a company may have millions of shares on offer. Therefore, your entitlement will be small.
Not all companies will pay dividends though.
If a company is young and growing, the directors may decide to put the profits back into the business to grow the business instead of paying profits to the shareholders.
If a company is doing poorly, it may not be able to pay shareholders due to lack of profits.
If you’re young and don’t need the cash, a wise move is to reinvest the dividends into the company’s Dividend Reinvestment Program if they have one. This means that instead of receiving cash, you receive extra shares equal to the value of the dividend. The compounding effect will work in your favour.
Once again though, when you receive a dividend, even if you reinvest them, the tax office will put its hand out.
Always keep paperwork you receive as a result of being an investor. All buy or sell documents, dividend notifications, anything to do with money. Your accountant will thank you.
Franking credits
Dividends are paid out of profits which have already been subject to Australian company tax which is currently 30%. This means that shareholders receive a rebate for the tax paid by the company on profits distributed as dividends.
These dividends are described as being ‘franked’. Franked dividends have a franking credit attached to them which represents the amount of tax the company has already paid. Franking credits are also known as imputation credits.
According to the ATO, franking credits are a type of tax credit designed to prevent “double taxation”.
Double taxation means, without franking credits, the company pays tax on its profits, then you pay tax on the dividends paid from the after-tax profits of the company. The government would get two lots of tax from the same amount of money.
Franking credits overcome this issue.
Effectively, if your tax rate is higher than the company tax rate of 30%, you pay tax on the difference between your tax rate and the company tax rate. You don’t pay tax on the full dividend.
If your tax rate is less than 30%, you may receive a refund. This is important to retirees who use dividends to fund their retirement.
The “franking” of the dividend varies from 0% to 100% between companies. For example, Commonwealth Bank, Telstra and Rio Tinto have 100% franked dividends while Macquarie Group franking is between 60-80%.
A company is not eligible to give you a tax credit if it does not pay tax in Australia.
If your dividend received is fully unfranked, the dividend is fully taxable.
Should franking credits determine your selection of investment? Not necessarily, but it is something that you should be aware of.
Although tax matters should not drive investment decisions, tax does have an impact on the outcome of your investing efforts.
Feel free to research franking credits. It’s a bit heavy going and really just something to be aware of in the early stages of investing.
How to start in shares
- Open a trading account with trading platforms such as Commsec, Superhero, etoro, CMC Markets (there are many others). Do your research and understand the costs involved.
- Put money into the account.
- Decide on how you will make share selections. Will you do your own research or pay for purchase recommendations?
- You will pay a brokerage fee to purchase the shares. This cost depends on the platform. The cost is tax-deductible.
- Keep all paperwork.
- Track your performance. An excel spreadsheet for example. Benchmark your performance against the market index (discussed in the next article). Can you beat the market? If not, don’t waste time and money. Leave it to the professionals, or an index.
How to get good at investing
- Learn how to read profit and loss and cashflow statements, and balance sheets.
- Read Annual Reports.
- Subscribe to a research provider.
- Have an idea of how to value a company.
- Understand the industry, the competitors and the company you wish to invest in.
- Find under-valued companies or companies about to experience a growth phase.
- Understand the economy.
Fees
The only fees involved in owning shares directly is the brokerage fees to buy and sell. These fees depend on the platform your join.
Excessive buying and selling can increase costs that result in a lesser outcome for you.
If buying shares, plan your purchases. Instead of buying every week, save up for a few months and then make your purchase. For example, one purchase of $2,000 may cost $15 for the transaction. If you purchase 10 lots of $200 purchases, the fees are $150.
The Wrap
Buying shares is easy. Making money from buying shares is not as easy.
In the beginning, I recommend starting small. It’s should be about learning and gaining experience. Only play around with money you can afford to lose.
It is important to know what you want out of a share purchase. If you are randomly picking shares because you know the name of the company, you’re guessing/gambling.
Are you after capital growth or income from dividends? You may receive both from a particular company.
The aim of investing is to maximise your returns based on the risk you are prepared to take. This may mean leaving your ego at the door. It is important to track your performance. If your annualised return is 8% and the market increased by 12% within the financial year. You lost out.
Consistently beating the market is almost impossible. The odds are against you.
Just in case I hadn’t made it clear – keep all paperwork in an organised manner so when it comes to tax time your life is made much easier.
If it’s all too hard, and to do it well is very hard, there are easier options.
Up next …..
Managed funds.
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