Most Australians view shares as being a risky investment. In fact, I used to think the same. Growing up, my mother dated a man who had lost his entire fortune on the stock market as a day trader. We heard the story as a lesson to us not to invest in shares.
It wasn’t until 30 years later I discovered there was more to shares than tales of woe and ruin.
There was another way – shares could be bought and held for the long term providing a perpetual source of income. These shares as an ongoing source of income could even be handed down the generations or donated to charity.
Buying and holding shares had nothing to do with the risky get rich quickly day trading buy and sell strategy. It is all about being an investor – not a trader.
Intrigued, I just had to know more.
What Is A Share?
When you buy a share on the stock market, you are buying a share of an already established company.
In effect, you become part owner of the company you own shares in.
For example, if you purchased shares in Telstra, you become part owner of Telstra. And not only are you the part owner of a business, you also receive part of the profits from the business.
You may have heard the words ‘shares, stocks and equities’. These are all words that mean the same thing and can be used interchangeably.
In Australia, shares are listed on the ASX – the Australian Securities Exchange.
What Are Dividends?
As part owner of a business you’ll receive a share of the profits of the business. This income is called a dividend.
Most companies listed on the ASX pay out dividends twice a year. However, some companies may decide not to pay dividends. They will instead reinvest the profits back into the business to enhance growth.
If your goal is to receive an income from dividends, you will need to buy shares in companies that pay dividends.
In the growth phase of your investing, it’s recommended that any dividends you receive are re-invested back into the share market to buy more shares.
Using the Dividend Reinvestment Plan (DRP) of the company you own shares in means any profits you are due are automatically used to buy more shares in that company. This is without the need to pay brokerage fees.
As an extra incentive, some companies DRP may issue new shares at a discount to the current listed price on the ASX.
DRP assist you to increase the size of your investment in a company. It also has the added benefit of compound interest – where your interest (dividends) earns interest.
What Are Index Funds?
Index funds were created in 1975 and completely changed stock market investing.
So instead of having to figure out which individual companies to invest in, John Bogle took the complexities of thousands of stocks and turned it into a single entity – the index fund.
This made investing in the stock market easy, low cost and minimised risk. Index funds gave investors the ability to own a broad range of stocks at a low price by paying an intermediary.
The intermediary company Bogle founded, Vanguard, now manages US$5.1 trillion in assets – they charge a small fee in exchange for spreading your money out across the market. The more diverse your investing is the less risky.
For example, when you buy into the Vanguard Australian Shares Index Fund, known as VAS on the ASX, you are buying into a fund that seeks to track the ASX 300 index (the top 200 companies listed on the ASX plus another 100 smaller companies).
By buying into VAS you will own shares in: (current as at April 2019)
- Commonwealth Bank of Australia
- BHP Group Ltd.
- Westpac Banking Corp.
- CSL Ltd.
- Australia & New Zealand Banking Group Ltd.
- National Australia Bank Ltd.
- Macquarie Group Ltd.
- Woolworths Group Ltd.
- Wesfarmers Ltd.
- Telstra Corp. Ltd.
And that’s just the top ten VAS holdings which represent 42.3% of the holdings.
What Are ETFs and LICs?
When looking into index funds, you may notice the terms ETF (Exchange Traded Funds) and LIC (Listed Investment Companies). ETFs and LICs are similar to traditional index funds, yet have differences.
The goal of an ETF is to track and replicate (copy) the ASX index. There is no guess work for the fund in which shares to buy and there is no active management in trying to outdo the stock market. Historically, ETFs have outperformed the actively managed funds. They also have lower management fees (MERs).
LICs on the other hand, actively manage a diverse range of shares from the index. Their goal is to outperform the index, yet this also means they may underperform as they are not simply tracking the index in the same way as an ETF. When looking into LICs ensure they have a low MER.
Some Australian investors prefer LICs to ETFs. This is because ETFs track the ASX and a large portion of the index is in the ‘financial sector’ which doesn’t allow for much diversity. Over in America there is much more diversity in their index resulting in different recommendations.
Research which type of investments suit you best.
How Do You Buy Shares?
To buy shares you’ll need a broker and the cheapest way to do that is to use an online share broker. It’s as simple as signing up with an online share broker. Ensure you research which online broker provides the best deal for you.
Warren Buffets advice to buying shares is to “be greedy, when others are fearful”. When the stock market prices are low, that’s the time to grab a bargain, much the same as grabbing a sale item at a supermarket.
For example, if a stock is usually $7 a unit and you have $1000, you’ll be able to purchase 142 units with each unit earning a dividend (depending on the investment). However, during a stock market low, or a crash or a bear market, those same shares may be selling for $4 a unit. Now for your $1000 you’ll have bought 250 units and that’s a whole lot more earning potential than having 142 units.
The other method for knowing when to buy is called dollar cost averaging. This involves investing the same amount of money at regular intervals whether the share market is up or down because in the long term it averages out.
- Bear market – when share prices drop, much like a bear swiping its paw downwards.
- Bull market – when share prices rise, similar to the upwards thrust of a bull’s horns.
Thanks for taking the time to read about shares, dividends, the ASX, DRP, index funds, ETFs, LICs and MER.
I know I immensely enjoyed learning about the share market and I hope you have too.
If you haven’t yet, I recommend you calculate your net worth to gain an understanding of your current financial situation.
Disclaimer: I am not a personal finance adviser. Do your own research and contact a professional as needed. And as the Barefoot Investor says ‘tread your own path’.