Friday, 15 June 2012

Should I buy shares?

by Rob d'Apice
Shares are to finance what diets are to weight management. There's a billion different people spruiking their own philosophy, each with plenty of testimonials and each with an amazing track record of success. But when you strip away the marketing spin, the tried-and-true key to success is always disappointingly unsexy.

To lose weight: eat less calories than you burn.

To make money with shares: diversify your portfolio and hold for the long term.

What is a 'diversified portfolio'?

Diversification is the strategy of spreading your investment over a variety of products and investment classes to reduce your risk exposure to any one particular investment.

But hold on, Prosple. I *know* that mining shares are currently undervalued and I can make a quick killing by buying a bunch of BHP stock now, right?

The risk with trying to 'pick' the undervalued stock (to buy) and overvalued stock (to sell) is that there are many, many traders (from massive investment firms to individuals) trying to do the same thing that have more experience, time and resources to analyse those stock. The current stock price is a reflection of their collective research - if they thought those stock were undervalued, they'd be buying them up, which would push the price up to a point where investors stopped buying.

Banking on yourself to know that the market has got it wrong is a big call. And a risky one.

An easy way to hold a diversified share portfolio is through an index fund. For example, an ASX 200 fund will invest in the stock of the largest 200 publicly traded companies in Australia (in proportion of the size of each company) - so that you money is spread over many different industries, products, management teams, etc.

Alternatively, you could look for an actively managed fund that invests in a broad range of Australian shares, or you could construct your own diversified portfolio of shares (but it might be best to consult an adviser to help you with this; you'd probably need a sizeable initial investment to make it worthwhile).

What is 'long term'?

If you're investing in shares, you should realistically be thinking of leaving that money tied up for at least 5-10 years. Take a look at this:

The chart above shows you how much an investment of $1,000 would be worth today, depending on whether you put your money in an online savings account (orange) or invested in the ASX 200, an index that tracks the collective performance of Australia's top 200 shares (black).

For example, say you invested $1,000 in Australian shares 5 years ago - that would now be worth $767 today. If you'd put that money into a online savings bank account, you'd now have $1,303. That's quite a difference right there.

In fact, as you can see, if you invested in shares anytime over the last 8 years, you would have been better off keeping it in a savings bank account. But have a look at the same chart, now stretched over 20 years:

Historically, it's clear shares are the big winner in the long run - $1,000 invested 20 years ago is $5,252 in shares, but only $3,232 in a savings account.

So while it's clear that shares can provide a good source of long-term wealth, you should be wary of any investment that promises a faster return. Whether it's acacia berries that make you lose 30kg in just 1 week (I'm a size 12 again!), or forex trading that nets a stay-at-home-mum $1,000 a day (I've got the cheques to prove it!) - if it sounds too good to be true, it probably is.

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