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Why individual shares are better than buying the index

Everyone in Australia will be better off if they invest versus not doing anything. Whether it’s property or shares, both will hopefully generate pleasing returns over the coming years.

However, there is a major difference between Australian and overseas shares.

Australia’s biggest companies are made up of slow-growing (at best) businesses that have already saturated the market they operate in. The big four banks, Telstra Corporation Ltd (ASX: TLS), Wesfarmers Ltd (ASX: WES), Woolworths Limited (ASX: WOW) and BHP Billiton Limited (ASX: BHP) are the main players in the index.

Therefore, if you look at the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) index you will see that it’s dominated by these slow growing companies. They pay out very pleasing dividends which is good for the short-term, but owning the index in the long-term will not see as much growth.

Compare that to the American indexes. They have a number of businesses that are nowhere near done growing such as Apple, Facebook, Amazon and Berkshire Hathaway. These businesses will provide a lot more growth over the years to come.

So why does paying out a larger dividend result in an inferior result?

The answer is compounding returns.

If a business can generate, for example, a 20% return on the money it invests back into the business, this re-invested money should grow the value of the business and therefore the share price at a fast rate. Alternatively, the company could pay out the cash as a dividend and the shareholder’s return is only whatever the dividend yield is, which could be 4%. Re-investing grows the value of the business at a more effective rate than receiving a bigger dividend.

Indexes around the world are valued at close to multi-year highs, perhaps even all-time highs. Investors who invest in indexes now are not paying any attention to the underlying value of what they’re buying, which is a key part to investing.

There are a lot of reasons why index funds are a good idea. The internationally-focused indexes are a good option for Australian investors.

However, the Australian index is too heavy on a few businesses in two or three industries. Essentially, it is defeating the purpose of an index.

Foolish takeaway

Instead, I think it would be much better to buy individual businesses such as Challenger Ltd (ASX: CGF) and Ramsay Health Care Limited (ASX: RHC). Both these businesses have long growth runways and are re-investing around 50% of their profit back into the business.

Challenger and Ramsay aren't the only great growth stocks, this report outlines even more great options.

Top 3 ASX Blue Chips To Buy In 2017

For many, blue chip stocks means stability, profitability and regular dividends, often fully franked..

But knowing which blue chips to buy, and when, can be fraught with danger.

The Motley Fool's in-house analyst team has poured over thousands of hours worth of proprietary research to bring you the names of "The Motley Fool's Top 3 Blue Chip Stocks for 2017."

Each one pays a fully franked dividend. Each one has not only grown its profits, but has also grown its dividend. One increased it by a whopping 33%, while another trades on a grossed up (fully franked) dividend yield of almost 7%.

If you're expecting to see the likes of Commonwealth Bank, Telstra and Wesfarmers shares on this list, you'll be sorely disappointed. Not only are their dividends growing at a snail's pace, their profits are under pressure too due to the increasing competitive environment.

The contrast to these "new breed" blue chips couldn't be greater... especially the very real prospect of significant share price gains, something that's looking less likely from the usual blue chip suspects.

The names of these Top 3 ASX Blue Chips are included in this specially prepared free report. But you will have to hurry. Depending on demand - and how quickly the share prices of these companies moves - we may be forced to remove this report.

Click here to claim your free report.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Telstra Limited and Wesfarmers Limited. Motley Fool contributor Tristan Harrison owns shares of Challenger Limited and Ramsay Health Care Limited. The Motley Fool Australia owns shares of Challenger Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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