You’ve worked hard for your money. Made sacrifices and saved as much as you can. Your money is earning very little interest in the bank. It’s time to turn the tables and make your money work hard for you.
Long term focus
Over the long term, the ASX has done exceptionally well, growing faster than most other asset classes. However, this growth hasn’t been a straight line up and to the right. The recent market pullback from COVID-19 is a perfect example. The S&P/ASX 200 Index (ASX: XJO) is still down around 27% from its February highs.
That was only 2 months ago. Turn 2 months into 20 years and your historical chance of losing money from market returns is basically nil.
Shares can be volatile and so it’s important to protect yourself from this volatility. This is even more important when you may be relying on (all or part of) your investment portfolio to fund your retirement. You may not have 15 or 20 years to wait for your portfolio to rebound from the worst of recessions.
In my view, diversification should be implemented through:
- the number of shares you own – at least 15;
- holding shares with a variety of market capitalisations – small, medium, large and mega cap;
- owning businesses in multiple industries; and,
- having businesses which operate in different geographies.
The more shares you own, the maths suggests you will revert to the average. However, as a stock picker, you can avoid a lot of the low-quality companies which you would be buying as part of the index. Outperformance is definitely possible whilst being diversified.
A company can either reinvest its earnings or pay them out to shareholders in the form of a dividend. A lot of investors focussed on retirement really like or need income and accordingly invest for dividend yield.
This isn’t inherently a bad thing, especially in Australia where we receive a tax offset in the form of franking credits! But it is worth remembering that your total return, the sum of capital growth and dividend yield, is most important. Dividend payers deserve a portion of your portfolio, but they are often stable, mature and to my point, slow-growing businesses. If you only invest for income, you may be missing out on some growth.
The Warren Buffett way
By focussing on total returns, you can implement one of Warren Buffett’s strategies – selling down your portfolio when you need funds. This can take a bit of planning, to ensure you don’t need to sell as much during a recession, but the effect of compounding your portfolio at a slightly higher percentage can have you much better off.
You may not receive as many franking credits investing like this, but depending upon how you legally hold the shares, will receive the CGT (capital gains tax) discount for shares owned for more than 1 year.
Man who said buy Kogan shares at $3.63 says buy these 3 ASX stocks now
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Motley Fool contributor Lloyd Prout owns shares in Aristocrat Leisure Limited and expresses his own opinions. The Motley Fool Australia owns shares of and has recommended BetaShares Asia Technology Tigers ETF and Telstra 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 Scott Phillips.