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 Do The Experts Recommend?
Because I’m not an expert on the share market, I’ve researched what the experts recommend. Here’s what I’ve found out.
Warren Buffet is considered one of the world’s most successful investors. He has a net worth of US$82.4 billion dollars. On his passing, Buffet is leaving his entire inheritance to his wife in shares in a simple low cost index fund.
Way back in 2007, Buffet made a bet with numerous fund managers that a simple low cost index fund would perform better than an actively managed fund charging high fees. By 2017, the index fund outperformed all the actively managed funds.
Peter Thornhill is an Australian author who wrote ‘Motivated Money’. He has $11 million dollars invested in the share market and receives an annual dividend income of $400,000.
When asked about what he thought of Listed Investment Companies (LICs) by Strong Money Australia, Thornhill said:
“They are simple, they have been around for decades…too many people become slaves to their money. Money remains my slave so that I can focus on what really matters in life.
“LICs enable us to sit back and get on with all that life has to offer…my simple selection criteria is that they must have been going for a minimum of 50 years and the management must be integral. Reason for 50 years is that I am singularly unimpressed by the carpetbaggers who have entered the industry over the recent decades.”
Australia’s Barefoot Investor and best selling author has this to say about index funds:
“Let’s talk about how you can mix the magic of compound interest with the most powerful wealth engine in the history of the world: the sharemarket. That’s the Golden Ticket to never having to worry about money again…the biggest risk is not owning shares.
“[Index funds] give fantastic diversification. As little as $500 will give you a very small holding in every one of those 200 companies that constitute the ASX 200.
“Index funds are hugely popular, with trillions of dollars invested in them all over the world…”
Canadian, turned American, Peter Adeney retired at age 30 by saving and investing at least 50% of his income into, you guessed it, low cost index funds.
“But WHICH stocks do I want to buy to make this free money?
This is the easy part. You buy ALL of them. The world’s smartest people have done incredible studies on this for over 40 years. What they find is that the best way to make money in the stock market is to simply buy an index fund”.
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.
Which Shares Do The Australian Experts Recommend?
Living in Australia, it’s useful to know which shares the Australian experts recommend.
The following list is a combined summary of recommendations by Peter Thornhill, Scott Pape, Aussie Firebug and Strong Money Australia.
- LIC: Argo Investments Limited (ASX: ARG)
- LIC: Australian Foundation Investment Company (ASX: AFI)
- LIC: Australian United Investment Company (ASX: AUI)
- LIC: BKI Investment Company Limited (ASX: BKI)
- LIC: Milton Corporation Limited (ASX: MLT)
- ETF: Vanguard Australian Shares Index Fund (ASX: VAS)
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 such as the popular Commsec (part of the Commonwealth Bank). Commsec is free to join, there are no ongoing fees and you can buy shares with as little as $500. Brokerage is $10 for trades under $1000. 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.
What Do Shares Have To Do With Financial Independence?
F.I.R.E. (Financial Independence Retire Early) proponents build their wealth by living frugally and saving and investing at least 50% of their income into low cost index funds.
In a nutshell, they calculate the annual income they would be happy to live from, save 25 times that amount and invest it, and live off the dividends as a perpetual source of income.
For example, if a person invested $60,000 per year at an 8% return and reinvested the dividends, in ten years due to compound interest they will have $998,729.
To ensure they never run out of money, they only ever withdrawal 4% from their investment each year. This allows for inflation as the stock market historically returns an average of 7 to 10%.
Assuming you have $1,000,000 invested at 8% and withdraw 4%, you will have $40,000 for the year, leaving the other $40,000 invested. This allows your money to continue to grow and keep up with inflation.
Thanks for taking the time to read about shares, dividends, the ASX, DRP, index funds, ETFs, LICs, MER and what the experts recommend, as well as the F.I.R.E. strategy.
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.
Have you heard of the online broker SelfWealth – it’s who we use and I can highly recommend them. Each buy or sell trade only costs $9.50 – no matter how much you are investing. Here’s a link if you’d like to try them out. The link entitles you to 5 free trades (and we get 5 free trades as well). https://secure.selfwealth.com.au/Registration/Plan/5/K2qDn
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’.