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.
