Why Shares?

Share investments produce returns similar to those produced by Real Estate. In fact shares often out perform real estate as an investment over some periods of time.

The table that appears below shows returns during the 10 years to February 1995. During this period both real estate and the share market were exposed to “boom” conditions. The period represents a fair and reasonable “level playing field” to make such comparison.

This article does not seek to promote any one form of investment over another. All investment media are able to contribute to the future wealth of the investor.

It is important to understand that to use three of the major investment media at about the right time and in the right order – will produce greater results, sooner, than the use of just one.

A major advantage with regards to share investment is the ability to commence quickly and with little capital. As little as $1500 will purchase a small parcel of shares which have the same growth factor as larger parcels.

The share portfolio can be accumulated as funds become available as opposed to the requirement for real estate where a large commitment is required.

Additionally, a part of the whole share portfolio can be sold very quickly (a cheque within a week) if some financial calamity occurs.

A forced sale of the real estate invariably incurs a loss and the time frame necessary to affect the sale can further aggravate the circumstances that forced the sale. Unlike real estate, price movements of shares are far more volatile which means that while spectacular capital growth may be seen, drops in value also occur.

Despite these rise and falls, the proper selection of shares will result in a steady steam of dividends and other benefits, including capital growth. These often produce a better return than interest rates given the taxation credits that accompany the dividends received.

The manner in which shares may be utilised for investment, generally speaking, is threefold:

• Purchased for the long term – usually considered to be in excess of 10 years. The result should be returns compatible with real estate investment.
• Purchased following the recession which occurs each cycle. The profits made are then used to purchase real estate which allows participation in the rapid price growth that follows.
• Purchased for trading purposes. That is, shares in selected companies are purchased with a view to short term profits. The profits are then used to repeat the process. A high level of skill and experience is necessary to become a successful trader.

The major difference between the other two forms of investment is that shares rise rapidly and then contract downwards increasing a sense of loss.

Real estate, on the other hand, may show little real gain over a number of years and then a large gain during a two year period or so. Prices moving downwards however are rare. The perception then is that real estate does not loose money, it does, but it is not evident.

The major advantage of shares is that the amount invested is able to be tailored to the funds available. Reduction and increases in the share portfolio are able to be made simply and easy.

Real estate, through, requires a large bite of the finance and funds available and in the event of financial difficulty, the entire investment needs to be divested.

The result is invariably a loss as the high acquisition costs are received with a tax credit if the share purchases have been sensible. The effect is a considerable advantage in servicing loans used for the purchase.

When to buy Shares?

The period eagerly awaited by investors is the emergence from the recession part of the economic cycle. This awakening appears to be a slow process.

It is ill - defined and community attitudes tend to reflect the stories of doom and gloom associated with the recession. Pessimism and cynicism are ingrained. It is easy to be aware after the event, not so easy to foresee the event.

Recessions recede as a consequence of the human spirit. The fear of losing our jobs gradually takes a second place to the needs of our families and ourselves. Growing optimism gradually overcomes pessimism, consumer confidence and improves corporate profits rise and the employment situation brightens.

The event is not proclaimed by the ringing of a bell. Maintaining a sensible level of optimism will provide sensitivity to the subtle changes that occur.

Purchasing shares earlier or later makes very little difference to the end result. Timing is not super critical, even a year too soon is of little consequence.

Use the economic clock to determine that share purchases are appropriate to the economic cycle. This is usually three of four years after the previous peak of the share market.

Investment in shares, three years after the previous peak, almost always produces returns greater than those available from interest in that particular year. For complete safety, entry into shares may be left until four years from that date of the previous peak.

The Stock Exchange

The stock exchange is the store window through which we have access to the shares of the companies who produce provide and service the Gross National Product.

The share broker is the person in the window who advises and ensures that instructions are carried out.

Shares, also known as stock and equities, are simply the right to share in the prosperity or otherwise of Public companies. They denote part ownership of the particular company. They may be compared to the deeds of the real estate property.

Shares increase in average value during the appropriate period of the economic cycle and, in addition, most also return a dividend or portion of the profits made by the company. Dividends should be ploughed back into the investment portfolio to achieve the benefits of compounding.

When contracting a share broker, it should be explained that guidance would be appreciated and the broker will be happy to give assistance and advice. No charge is made for opinions. Brokers are generally knowledgeable and helpful.

A request should be made for the recommendations of share companies who capitalization vale is used in the calculation of the All Ordinaries Index, and may reasonably be expected to do well over the next three to five years. Shares purchased should be in the top 200 companies to provide safety.

Whilst share brokers are very polite, knowledge and helpful in share broking companies sometimes have interests in companies they recommended and it is required that you be informed of this.

The prudent investor asks two or three different brokers the same questions to determine if a difference of opinion exists.

As savings permit, additional shares may be purchased in different companies which meet the same criteria. This spread of investment will ensure that the performance of a share portfolio will approximate that of the All Ordinaries Index.

When to Sell Shares

Knowing when to sell shares is one of the more difficult investment exercises. The following may be useful as a guide.

The previous two year cycle of the collapse and recovery of the share market show that from the bottom of the market to the next peak, the Index increased by over four times.

The September 1974 All Ordinaries Index was 174, which was the bottom of the market. November 1980 was the next peak achieved when the All Ordinaries rose to 733. That equals an increase of 321% above the previous low.

In July 1982, the All Ordinaries Index bottomed at 465 and peaked in October 1987 at 2,280. That equals an increase of 390% above the previous low.

The selling indicators suggested are:

• Seven years from the previous peak;
• When the index has climbed to three times the previous low; or
• When share prices rise above the underlying values that justify the price. This may be when average Price/Earnings (P/E) ratios have increased to 23. Ordinaries Index is 23 times the average dividend earnings.

Generally, the faster the All Ordinaries Index increases, the sooner the share market will peak.

If the choice is made to retain shares beyond these criteria, an extremely careful watch should be maintained as very little warning, if any, is given of the downturn.

The share market All Ordinaries Index has increased by well over four times its previously low in each of the last two cycles, therefore selling at three times this figure may seem conservative.

The final run of the market from three to four times can be very rapid and the three times suggestion is meant to provide a degree of security.

The rapid rise during the final few months of the share market ‘bull’ run (rise) can prove a powerful lure to “Hang in there”. Remember the adage: “You cannot go broke taking a profit”.

When shares are purchased early in the cycle, the prices are usually such that even after the collapse, a profit will result.

The lowest degree of risk exists when the All Ordinaries Index is below the previous high that was reached prior to the last collapse of the market. The all Ordinaries Index is below the previous high that was reached prior to the last collapse of the market. The All Ordinaries Index has never failed to exceed the previous high.

The rate of growth of share prices is usually greatest turning the twelve months prior to the peak. The increase is greater then the increase in the preceding year which in turn is greater than the increase in the year before.

Therefore, it may be seen that buying shares during the period that the market is increasing still provides good returns.

The resource stocks, for instance mining companies, generally start rising a little later than industrials due to stock piles of commodities accumulating during the recession period.

Commodity prices have little rise unit these stockpiles are depleted sometime after the business cycle becomes more active. As the stockpiles deplete, the mining industry comes on stream as commodity prices commence to rise.

Staying In

If shares are held beyond the peak of the share market, the appropriate action to take would be to immediately dispose of shares in any company considered insecure. Retain the shares of solid companies and perhaps purchase additional shares in the aforementioned companies when the prices are at their lowest.

This has the effect of lowering the average price of shares held in the portfolio. Consequently, higher profits are gained as the value of shares rises during the next cycle. This process is known as averaging and is a useful technique at any time.

Holding shares over a long period is a good investment. This is despite the periodic rises and falls that the market experiences. (This practice will generally produce returns on investment similar to the returns enjoys from real estate without the cost and inconvenience of finding a suitable tenants or the money for annually increasing rates.)

The performance of the share market index is often quoted to average the inflation rate plus 10%, plus the dividend rate per annum compounding. This average included rises and falls.

This may give the assurance that despite the periodic collapse of the market, the recovery will ensure that profits eventuate.

Whilst we look into this program to achieve greater returns, the share market by itself is a profitable investment. In fact, actual returns from long term retention of shares compares favorably and often exceeds long term retention of real estate.

How Safe

Before the shares of any company are used in the calculation of the All Ordinaries Index, that company is required to meet certain standards to the satisfaction of the Australian Stock Exchange. This criteria includes the percentage of market capitalisation of that particular company.

The ideal situation would be to have shares in all of the companies that make up the All Ordinaries Index in the proportion that they contribute to the index. This can be achieved though investment in units in Managed Index funds.

When units are purchased in one of these funds the money is pooled with the other investors and shares are purchased in the companies that make up the Index in the correct proportion.

For example, if BHP shares represent 8% of the sample, then 8% of the funds are invested in BHP shares.

This ensures that the performance of these funds matches that of the All Ordinaries Index.

Fees are paid to join one of these funds and additional fees are deducted from the profits to pay for the staff, overheads, management and trustees of the fund. Profits or losses are then transferred to the account of the investor.

As an example of the dilution of returns, consider a managed fund where the fund manager receives 1.5% of the total value of the fund each year and the trustee receives .5%.

Assume the total value of the fund is $1,000,000. (The total value of these funds is well in excess of this figure but relativity remains the same). The fee taken by the manager and the trustee is $20,000 and at first appearance this may not seem excessive.

Now assume the fund made a profit of 10% or $100,000. The $20,000 fee is actually 20% of the profits and in the case where the fund made 5% or $50,000, the fee taken represents 40% of the profit. This is before entry, exit and other fees are considered.

Indications are that a much better result is achieved through personal investment acting on a broker’s advice.

This may be because, at any one time, some of the companies who are part of the index sample are not performing well. Thus the poor performance of the companies, in addition to the fees taken, is reflected in the returns to investors.

In the case of personal investment the poorer performing companies may be excluded from the portfolio resulting in the opportunity if better net returns.

This greater flexibility is one of the factors that contribute to personal investment out- performing managed investment.

Generally, the shares purchased should be held for the full term of involvement in the share market, subject to sub stained advice received from a share broker.

Safety is assured if:

• The shares purchased are confined to the large, well managed companies with high capital values. These are generally within the top 200 listed companies.
• The shares are recommended by a broker to meet the criteria given. That is, analysis shows that the shares of that company should match the performance of, or out-perform, the All Ordinaries Index over a three year period.
• The shares are held for the full period of the business cycle unless some extraordinary event occurs dictating that the particular company’s shares should be sold.
• Shares acquired should be in companies within differing industry sectors, as suggested by a broker. For example: food, transport, building, resources, media, banking and so on.

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