What would you do if we said you were missing out on an investing strategy that, in the long run, has produced returns that far outweigh those offered by a bank? One that outperforms cash in a term deposit or savings account? Well, meet the share market.
Internet bubble and global financial crisis (GFC) included, according to 2010 research by Credit Suisse, Australia has had the best performing share market in the world from 1900 to 2009. Australia posted 7.5% after-inflation returns per year during that time, making those returns the highest (with volatility the second lowest) of the 19 major markets the researchers studied.
The recent global financial crisis shook many people's belief in shares. Some people, battered and bruised by the experience, have sworn off the share market for life. Sure, they made some mistakes and some poor investments, but that's part and parcel of investing. As the old saying goes, if at first you don't succeed, try, try again.
How about this for some motivation?
In the 2010 Russell Investments/ASX Long-Term Investing Report, up until the end of 2009, Australian shares outperformed all other investment sectors delivering the best after-tax and after-cost returns at the lowest and highest marginal tax rates across the last 20-year period, with an annual return of 9.9% and 7.8% respectively.
For the purposes of complete transparency, it should be noted on a before-tax and after-costs basis, residential investment property outperformed all other sectors, returning 9.8% annually – just ahead of Australian shares at 9.7%.
Shares vs Property
We're not about to get into a debate here about the relative merits of Shares versus Property*, but since we're all about shares, we hope you don't mind if we just stick to the share market for now.
* As a clue, we won't find much or any information here about the merits of investing in residential property. Let's just say, we broadly agree with Gerard Minack of Morgan Stanley who said in August 2010 the explosion in house prices in the past decade had forced them well beyond "fair value". As to whether that means a house-price crash is imminent, we have our doubts. But as a form of investment, current rental yields are generally very modest, and we think capital appreciation is likely to be well below the levels seen over the past decade. Lucky we said we're not getting into a debate…
The bottom line is we think investing in the share market can be financially smart, simple, inexpensive, and over time, help you generate life-changing wealth.
Think back to those tables from Step 1. There are no guarantees in life, but if you invested $1,200 per year for 40 years and you generated 9% returns every year, as is possible by investing in the share market, you could be half a millionaire.
Enough said?
Investing in the share market: funds vs. shares
You can invest in the share market by buying shares in an individual company, or by investing in a fund, which consists of a variety of shares in different companies – sort of like a basket of shares. With shares, as the value of the share itself (a publicly-traded company) goes up or down, the value of your investment does the same.
With funds, the value of your investment is tied to the value of the fund, which is reflective of the value of the shares the fund is comprised of. It follows that one share's movement has a smaller impact on the fund as a whole, and thus on you, than it would if you had all your money tied up in that share alone. You do pay a price for the relative stability of funds, and that's the fund management fee – all funds have these. We have more on the specific type of fund we like in our next step.
With shares, perhaps the biggest challenge with investing is knowing what to buy, when to buy it and when to sell it. It is a challenge, but if you get it right, and buy shares in a company like Woolworths (ASX: WOW) when it floated at $2.45 per share, the rewards can be truly remarkable.
As you'll see, we like the challenge of picking the next Woolworths, or the next Fortescue Metals (ASX: FMG). These are the types of investment successes that can make a massive difference to you, potentially setting you up for a long and very financially comfortable retirement.
But we believe funds have their place in your portfolio too. Not every fund, mind you. We're talking about funds with certain characteristics. But first, we'll have to introduce you to the dirty little secret "the industry" doesn't want you to know about.
Summing Up…
As a rule, the longer you invest for, the greater the chance that you'll do well. Investing for the short term, which we would describe as less than five years, is certainly risky. But when you're investing for your retirement you can afford to be a bit more patient.
