CHOICE guide to buying shares

The plunging share market is attracting bargain hunters. CHOICE guides first-time investors through their options.
 
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01 .Introduction

Shares board

In brief

  • Managed funds and index funds enable investors to regularly drip-feed small amounts into shares.
  • For those who want to buy shares directly, stockbrokers’ fees and services vary.
  • A company’s past performance is not an indicator of future performance.

In the past 18 months Australian shares have followed world indices deep into the red, falling by over 50% (see graph below). It’s been the second-worst crash in our share market’s history, and a devastating time for investors, particularly those who’ve seen the value of their superannuation funds plummet. Despite the market hitting a five-year low, the worst may not be over, with further ups and downs likely in this volatile and uncertain economic environment.

Nevertheless, some industry commentators say such declines have left Australian shares looking relatively cheap, providing capital growth opportunities for long-term investors. Some are calling this a “two for one sale”, pointing to the relatively low price of shares compared with company earnings, as well as dividend rates that far exceed the income you’d earn from a term deposit. They further point out that in the past, the Australian index has always rebounded from bear markets.

However, there’s no certainty that the domestic share market will rise again – or by how much and how quickly (they could continue to decline). It’s also worth noting that none of the experts predicted the extent of the global financial crisis we’re now experiencing.

Please note: this information was current as of March 2009 but is still a useful guide to today's market.


Your options

Should you decide to invest in shares, there are plenty of ways to benefit from a bounce-back, whether you have lots of money to invest at once or would like to “drip feed” small amounts into a share fund over time. CHOICE considers some of your options, including:

  • Buying shares directly through a stockbroker.
  • Letting an expert do the hard work for you with a managed fund.
  • Tracking the market with an index fund or exchange traded fund.

If you decide to take the plunge and invest in shares, make sure you understand the risk of further market declines and continuing volatility, and consider getting licensed financial advice.

Rise & fall of Aust. shares

Source: Australian Stock Exchange data quoted at www.abs.gov.au, except closing price for 2 March 2009, taken from www.asx.com.au

Shares don't always rise in the long term

There’s no guarantee that Australian shares will recover to former glories or, if they do, how long it will take. While it’s arguable Australian investors have been conditioned into thinking our share index will always go up in the long term, some other countries have had a very different experience. In Japan the share market has just hit its lowest point in 20 years and is now more than 80% below 1989 levels (as the chart shows). Not only has the Japanese index failed to recover from its crash in the early 1990s, when share values declined by 59% in just two-and-a-half years, it’s actually gone lower again and hasn’t shown any signs of recovery, with the economy in recession and predicted to continue shrinking in 2009.

Japan serves as a warning to all those investors who believe share prices must always rise.
Fall of Japanese shares

 
 

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You’ll need to go through a stockbroker to buy individual shares. If you don’t need investment advice, the cheapest way is through an online broker. Their fees start at about $15 per trade, up to $50 for the more expensive providers – the table below shows some of the stockbrokers’ products; they sometimes offer a range to suit different investors’ needs.

Check other fees, read brokers’ Financial Services Guides and Product Disclosure Statements before choosing one. All the major banks have an online stockbroking arm whose websites provide a range of services to help you research shares and other investments, including daily market commentaries, their analysts’ research, research from independent ratings agencies and company profiles.

For investors who want advice or to deal in large amounts of shares, a “full service” broker could be the way to go. They usually charge a commission of 2.5%-3% for share trades, with a minimum fee of $100. Their recommendations are covered by the fee – and this must be provided in a written Statement of Advice. The percentage fees are reduced for very large trades (six figures), while the cost to buy international shares is higher.

You generally need plenty of money to make direct share purchasing work, otherwise broker fees could make it uneconomical. One of the basic principles of investing is to diversify to spread your risk; if you invest all your money in just one or a handful of companies’ shares, you’ll be seriously affected if any suffer a major price decline or collapse. Some of our top 200 listed companies have lost more than 95% of their value in the past 18 months.

The Australian Securities & Investments Commission (ASIC) says successful investors own shares in about eight to 14 different industries across the economy. According to the commission’s website, “so long as you get a good spread across different industries, the investment literature suggests you don’t need to own shares in 30 to 50 companies.”

Did you know?

The Australian index is worth just 2% of global share markets. You can buy shares from other countries through stockbrokers, managed funds, index funds and exchange traded funds. Broker fees for international trades are higher and it’s not always possible through some online broker packages (see the table below for more).

Online stockbroker fees

If you don’t have the time, expertise or money to build a share portfolio by buying directly, consider buying units in a professionally managed fund. Managed funds pool investors’ money and do all the buying and selling of shares and other assets for you. Naturally, you pay fees for this fund management.

There are literally thousands of managed funds on the market, including sector-specific funds that invest in a particular asset or sector (such as Australian shares or international property) and multisector funds that spread investors’ money around a mix of asset classes (cash deposits, fixed interest, shares and property). This diversified approach spreads your risk.

The table below shows how the median Australian share fund performed over the last one, three, five and seven years (after fees) compared to the overall share market during the same period. Research house Morningstar supplied the data, which shows there was virtually no difference between the average professionally managed fund and the share market itself. The best managed funds outperformed the index, but predicting which managers will perform best is difficult.

Factors to consider

  • Provider Is it a well-known financial services company with a strong track record?
  • Excessive fees have a negative effect on your investment returns, so don’t pay too much. Annual management fees average 1.5%, which is deducted from your fund’s balance each year. Other fees can also apply, including an entry fee of up to 5% of your contributions, but much less through a discount broker. If you invest through a financial planner, fees are negotiable (as most planners keep some of what you pay as their commission).
  • Research where your money will be invested, including the mix of assets, sectors and companies.
  • Performance While past returns don’t indicate future returns, look for a fund that has performed consistently well against its peers and benchmarks over the medium and long term. Don’t just go for last year’s top fund, as it’s unlikely that short-term return will be repeated.
  • Amount Plenty of funds let you get started with amounts as little as $1000.
  • Study the managed fund’s Product Disclosure Statement. It should tell you most of what you need to know about the investment you’re entering.

Av. managed fund performance

Index funds

Index funds are among the cheapest way to invest in either the whole Australian share market or a portion of the index. These funds take the opposite approach to actively managed funds in which fund managers try to outperform their peers and chosen benchmarks. They attempt to track a safe benchmark: for example, the best-known index manager, Vanguard Investments, offers an Australian share index fund that aims to replicate, before fees, the performance of the S&P/ASX 300 Accumulation Index. Such index funds are “unlisted”, because they’re not quoted on the Australian stock exchange. Like managed funds (opposite), you buy units in an index investment from the fund manager, or through a financial adviser or broker.

The main advantage of index funds is their low fees, usually less than 1% per annum. On the downside, index funds won’t outperform the market they track or their chosen benchmark. Share index funds will invest in both poor- and well-performing companies, and may be less diversified than managed funds that invest in a range of asset classes (cash, bonds, property and shares).

The table shows two of the domestic index funds available to people with relatively small amounts to invest. International index funds covering sectors such as international shares, bonds, property and fixed interest are also available.

Aust. share fund performance

Table notes

(A) BPay = $100; cheque = $1000.
(B) For less than $50,000; fees reduce for larger amounts. na Not applicable.
ANZ launched this fund in November 2008, so performance fi gures are not yet available.

Exchange traded funds

Exchange traded funds (ETFs) are the cheapest way to track the performance of a particular share index. Essentially, unlike the unlisted investments in index funds, ETFs are index funds that are bought and sold like shares. Their main benefit is low fees, which start at just 0.29% for an Australian share fund. These listed funds also allow you to get instant diversification – with one trade you can become a part-owner in hundreds of companies. Like any other share, you’ll need to go through a stockbroker or online broker to buy ETFs, so consider broker costs in your decision.

Despite their low costs and accurate tracking of chosen share market indices, not many financial planners recommend investing in ETFs, perhaps because they’re not authorised to do so, or ETFs don’t pay them sales or advice commissions. Fee-for-service financial planners who aren’t reliant on commissions may be more likely to recommend investing in ETFs.

The ETF market is rapidly growing around the world, and has expanded in Australia recently with the launch of iShares, which tracks the performance of 16 overseas share markets. Closer to home, SPDRs (which originally came from the US title “Standard & Poor’s Depositary Receipts”) from State Streets Global Advisers give you the opportunity to track the local share market’s overall performance (see Useful Websites). The table below profiles Australian share ETFs.

Exchange funds performance

Superannuation

Chances are you’re already exposed to shares through your super fund. Ninety percent of people are in their employer’s default fund, which is where your money goes if you don’t make an active choice. The default is often a “balanced” option that invests in a mix of assets, including cash and fixed interest, and 60%-75% in property and shares.

Some super funds enable you to trade individual shares that are listed on the Australian Stock Exchange (trading fees apply). If you go down this path, it’s a good idea to make sure your super fund portfolio remains diversified between different companies, sectors and types of investments. Don’t put all your eggs in one basket.

What the experts say

In mid-February 2009, CHOICE asked some industry participants for their views about the outlook for Australian shares. Most were optimistic about the medium- to long-term prospects for Australian shares, cautioning that in the short term, prices could fall further. None of these opinions, however, are financial advice.

Shane Oliver, Chief Economist AMP: “Shares are now good value from a long-term perspective. There are bargains – shares with a high dividend yield and low price-to-earnings ratios. Dividend yields are attractive, at about 6.5% to 7% including franking credits, although I wouldn’t be rushing into shares with everything you have right now, as it’s too early to conclude the market has bottomed. It’s a good time to start averaging into shares.”

David Wright, Director Zenith Partners, which researches managed funds and provides recommended lists to financial planners: “We anticipate more volatility in the share market and there is some risk that it could go lower. If and when there’s a recovery it’s likely to happen quickly, with much of the rebound happening in the first few months. It’s very difficult to time the top and bottom of the market – I haven’t seen any professional investor do it. The best risk management strategy for new investors is to buy shares regularly through averaging in” (see Jargon Buster, opposite).

Savanth Sebastian, Economist CommSec: “Equity markets are weak and more falls could be on the way. However, price-to-earnings ratios are at their lowest level in 28 years and some companies are paying dividends of 8% to 10%. If you’re looking to invest in shares, take a defensive strategy, accumulating blue chips in areas like healthcare, telecommunications and consumer staples. Blue chip companies with solid growth prospect should be considered.”

Roger Montgomery, Chairman Clime Capital, boutique fund manager: “The time to be interested in investing in shares is when nobody else is, and that seems to be now. The key to share investing is to find great quality businesses that will grow profits over the next five to 10 years, but not at the expense of investors’ capital. Before investing, ask yourself if you have an understanding of how to value a business and assess its performance. If you don’t, use an expert [managed fund] or learn. Look for fund managers that follow an approach that provides great three-, five- and 10-year performance. Don’t just compare the overall percentage return during that time, but how it was achieved. Look for managers with a rational and commonsense approach.”

  • Blue chip shares While the term might convey a perception of safety or quality, blue chip really refers to the size of a publicly listed company. In fact, the original term came from the gambling world, as casinos’ highest value chips are blue. There’s no strict rule for what qualifies: one definition says companies need a market value of $1 billion, but to put this in context, Australia’s largest company, BHP, is worth about $168.75 billion.
  • Averaging in Also known as “dollar cost averaging”, is a strategy for buying shares by regularly investing. You might decide to put $100 into a share fund on the first Monday of every month. As the price of shares rises and falls regularly, your $100 will buy more shares when prices are weak and fewer shares when their prices are higher. Over the long run, the prices average out. This approach doesn’t guarantee profits, but can smooth the ups and downs.
  • Share index A way to measure the value of a basket of shares. The S&P/ASX 200 index, for example, represents the market value of our 200 largest public companies. It’s a “capitalisation-weighted” index, meaning that the size of a company determines what proportion of the index it represents. A change in BHP’s share price, for example, would have a bigger effect on the index than the same percentage change in a smaller company’s share price.
  • Points The value of most share market indices is measured in “points”, which represent the value of all the companies with shares on the index – for example, in mid-March the S&P/ASX 200 was at about 3200 points.
  • Price-to-earnings ratio This is a share’s price divided by the company’s annual earnings per share. It’s one of the key measures used to assess the attractiveness of a share’s price for investors, although it’s just one part of the puzzle.
  • Dividend yield A dividend is what’s paid from company profits to shareholders. The dividend yield is the annual dividend divided by the company’s share price, expressed as a percentage. You can choose to receive your dividends as a regular income (they’re usually paid every six or 12 months), or use the dividends to buy more shares (known as a dividend reinvestment plan).

Useful websites

 

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