Investing in shares
One of the most popular investments for self managed super funds, and indeed for many investors all over the world, is to buy shares in companies listed on a recognised exchange such as the Australian Stock Exchange (ASX).
Shares represent a part ownership in a business. So for example, if an investor buys shares on the ASX in a well known business such as the Commonwealth Bank, the investor becomes a part owner of that business. As a part owner, the investor then “shares” in the profits of the business, and is able to cast a vote on important items at the annual general meeting. It is generally accepted that the more profitable the business is, the more valuable the shares of the business should become.
By having shares, investors are able to trade their shares in that business with other investors. This is done via what is known as the “sharemarket”.
The sharemarket is the place where buyers and sellers meet to buy or sell shares, by bidding a buy price (buyers), or offering a sale price (sellers). Unlike the physical market place of years gone by, the sharemarket today is an electronic market, where buyers and sellers place orders to buy and sell shares, and can do this from virtually anywhere in the world with an internet connection via a stock broker.
Based on history, shares are generally accepted as the asset class that has the most potential to increase investor wealth over the long term.
This is accomplished in two ways:
If the company is making good profits, then they may distribute a certain percentage of these profits to the owners (the shareholders). These are known as dividends. In this era of ultra-low interest rates, dividends are often much higher than the interest being offered on Government bonds, cash, and term deposits. There can also be a tax credit attached to these dividends, which either acts to increase the income received or reduce the tax payable on the dividends, depending on the phase (accumulation or pension) the SMSF is in and its overall tax position.
As mentioned above, the more profitable the business is from year to year, the higher the likelihood that other investors will highly value the shares in that company, and hence offer higher prices to acquire them. There is also the fact that as the broad economy grows each year (although note that in some rare instances it doesn’t) this feeds into higher earnings for many businesses over time, and hence can be reflected in a rising share price over the longer term.
Whilst we have alluded to the fact that shares have the potential to offer returns well in excess of risk free investments such as cash and term deposits, the flip side is that they also come with higher risk and volatility.
Risk itself can be thought of in two distinct ways.
As a research house, Lonsec’s default position is that for the vast majority of investors, especially for SMSFs that are approaching retirement, speculative shares (such as in example 1 above) are not appropriate – or at the very least, should be kept to a very small percentage of an investor’s overall portfolio. Potential returns may be very high, but it comes with commensurately very high risk of permanent loss, with high levels of uncertainty. We tend to classify this as speculation, rather than investing, given the high level of chance that is involved in getting a positive outcome.
Including shares in a portfolio can be accomplished in a few different ways:
The first way is to invest directly in individual shares listed on the ASX (or other international exchange). To do this, and investor will generally want to have a process around their portfolio construction, and have access to high quality research on the shares they are selecting.
Exchange traded funds (ETFs) and Listed Investment Companies or Trusts (LICs / LITs) are vehicles listed on the ASX that enable an investor to gain access to an entire index or sector or strategy in one trade. They are a form of managed investment. See our articles in this series that explain how these work.
Managed share funds are another way to have an investment in shares. The investor’s money is pooled with that of other investors, and are allocated units in the fund. The fund manager invests this money on the share market on behalf of the fund investors. Just like with ETF, and LICs above, a mange fund can provide exposure to either an index, or a sector, or a particular share strategy. See our article in this series on managed funds for more information on how they work.
In our “Fundamentals” section we talked about how a SMSF portfolio can be broadly split into two sections – Growth assets and Defensive assets, and that it is the weighting to each of these buckets that plays a large role in your portfolio’s potential long term return, and short term risk & volatility.
Shares are the main asset used for the “growth” assets of a portfolio. In fact, for many investors they are often the only one used, although generally in a manner that provides sufficient diversification (e.g. around 12 to 15 individual stocks or 3 or more managed investments).
Share are the asset class that will drive the growth side of the portfolio the most, and can also offer (depending on the shares selected) higher income yield than fixed income in these days of ultra-low interest rates. Of course, the flipside of this is the higher risk and short term price volatility that comes with it.
As can be seen from all of the above, shares can be good long term investments, however there is an enormous amount of choice, and they carry substantial risks for both new and experienced investors. Thus, its important for investors to fully consider each individual share on its own merits before investing.
Lonsec are experienced hands with researching shares. Our research includes a comparison table on all ASX 200 shares, with a filter to enable you to refine your universe of shares based on a range of criteria. There are also model portfolios of Lonsec’s best ideas, across small/mid cap stocks, large cap stocks, and income focused stocks.
You can also download ASX 200 Stock Viewpoint pdf reports. These are a two-page summary equity research report inclusive of a stock rating, investment risk profile, company valuation, over or under-valued analysis, business snapshot, investment view, financial forecasts, bull & bear points and key trends and charts.
We also provide a wide breadth of research on ETFs, LICs / LITs, and managed funds that invest in shares, if that is your preference.
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