How To

Are you investing or speculating in shares?

By Market Index
Thu 17 Feb 22, 4:22pm (AEDT)

Key Points

  • All good investment plans will have one aim in common: Wealth accumulation over time
  • Investing in stocks over time has historically returned in spades
  • Sometimes it’s right to Sell or take profits in fully valued stocks off the table

Given the great flexibility and liquidity they offer, along with the added bonus of dividends and their history of repeatedly outperforming all other assets classes (including property), it’s hardly surprising that 74% (6.6 million) of Australia’s 9 million investors hold stocks (shares) or other on-exchange investments.

However, while Australians have a growing love affair with stocks, the reasons why they’re boarding the ‘equities train’ with growing alacrity are diametrically different.

The beauty of investing in the share market is that you can still be a successful investor, regardless of whether you’re defensive, balanced or aggressively chasing growth.

But if you don’t know what type of investor you are, or what your strategy is, you risk buying (and selling) stocks for all the wrong reasons.

It’s true, the advent of covid has made it trickier to work out what camp you belong to but given the heightened market risks it’s time to find out.

Unsure of why you’re buying stocks and for how long?

Here are some pointers to help you determine which camp – investor or gambler/speculator – you fall into.

For starters, investors will typically hold stocks over a pre-determined time horizon.

That’s because stocks are by nature risk assets which typically deliver better returns over longer timeframes. Sure, many investors like to have a speculative investment bucket, but this typically would account for only around 5% of a total portfolio.

The benefit of holding a diversified basket of both defensive and growth stocks is that those going up in value will offset those that aren’t, thereby smoothing out your returns over time.

Then there are the added benefits of owning stocks for over 12 months, which in Australia reduces your capital gains tax (CGT) to 50% when you sell for profit.

By comparison, those who “buy the stock price” and not the underlying company are, whether they realise it or not, gambling. This means the stakes – potential for loss – are a lot higher.

Buy or fundamentals not price momentum

Bottom line is, if you approach the stock market like it’s a casino, placing your bets on red or black, then your chances of a successful investing career are greatly diminished.

However, if you view the stock market as a place to pick top stocks, acquiring businesses that are run by honest and high performing managers and implementing a sensible portfolio risk management strategy, the opportunity to build your wealth over the longer term is vastly improved.

Investing blind is a dangerous game and sooner or later it’s going to catch up with you.

Admittedly, having a flutter at Randwick can be fun. But taking the same approach to buying stocks (or any other asset class) is not an investment plan, and everybody, regardless of how much (or little) they have to invest, should have one.

Where are you at financially?

Before devising an investment plan, it’s important to have an accurate picture of your cash flow, including income, regular outgoings – especially any discretionary spending – and your capacity to save/invest surplus money.

Sage advice from US investing guru Warren Buffett suggests spending what is left after saving, as opposed to saving what is left after spending.

Remember, all good investment plans will have one aim in common: Wealth accumulation over time.

The right investment plan for you will depend on a myriad of factors – most importantly your age, earnings and existing assets – which have a direct bearing on both your investment time-horizon - and risk/reward profile.

Stay invested

Highly volatile markets seem to bring out of the woodwork those who take great delight in warning you that the Sword of Damocles is about to fall on the share market.

Without doubt the likelihood of heightened share market volatility ahead is great. But it’s important not to run for the exits with your ears pinned back every time the market corrects.

Admittedly, that old chestnut about ‘time in the market’ sounds extremely old school.

But there’s no shortage of data to prove convincingly that investing in stocks over time returns in spades. For example, based on Vanguard data, $10,000 invested in US or Australian stocks in 1990, would by 2020 have returned 10.3% ($189,350) and 8.9% ($129,073) respectively.

The next best returning asset classes were listed property (7.8%), Australian Bonds (7.7%), international stocks (7.3%) and last but not least, you guessed it - cash (5.1%).

Do your own heavy lifting

Do your own homework before dipping your toes in the stock market, and never buy stocks on tip-offs or unsubstantiated rumours.

And while it’s important to stay “in the market,” that doesn’t mean buying stocks and parking them in the bottom drawer for ever, and ever amen.

The wakeup call for value investors is that in an environment where volatility is the “new norm,” a buy and hold approach may need to give way to a strategy for actively managing stocks.

So, stay alert to what the market is trying hard to tell you. Sometimes it’s right to sell, and sometimes it’s right to take profits in fully valued stocks off the table.

Written By

Market Index

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