There has been one thing that has been a constant and loyal companion in my journey of building wealth. And that is buying shares. I have been investing in shares in various different forms since I was about 21. My direct investing experience along with the many years of working for fund managers, investment banks, and private wealth management has given me confidence and enthusiasm for shares. But I get that if you’ve never done it before, buying shares can feel a little daunting.
If you are just getting started and don’t know much about shares or other types of investments, you might want to start with my post on Investing for Beginners. But if you’ve got a basic understanding of what the stock market is and what shares are all about, this is the post for you.
Before we dive in, I want to be clear that investing in the stock market isn’t appropriate for everyone. So before you place your first trade, make sure you are clear on what you want to achieve. Think about your appetite for risk. How long you have to invest? And how much time you want to put into the management of your investments.
Get rich slowly
Have you ever been at a BBQ and heard people chatting about buying shares in a certain company that’s going to make it big? Or, been told an urban-legend type tale of a distant uncle who bought shares in AfterPay when they were only $8 a share or bought into Pfizer before they invented Viagra?
This is not what we mean when we talk about growing wealth through shares. Of course, it’s possible to occasionally get lucky. But what you should really aim for is to invest in a broad range of shares across different industries so you can grow your money steadily over time. It might sound boring (it kind of is!) but it’s a far more sustainable and successful way to invest. Not to mention less anxiety-inducing!
A smarter strategy
So, while buying shares isn’t a get-rich-quick scheme, it can be very effective in growing your money over time. They can be a good alternative to the low return environment of a savings account. And require a lot less capital to get started than direct property. This Vanguard report shows that a diverse portfolio of Australian shares returned as much as 8.9% per year over the last 30 years. This is despite the Dot.Com Bubble, Global Financial Crisis of 2008, COVID-19 and other events. Certainly a lot better than the 0.95% you can currently earn on a High-Interest Savings Account in Australia right now.*
So, how do shares grow your money? Firstly, there’s the value of the share price. This should grow over time as the company gets bigger and delivers on its goals. If you paid a certain price for the shares, you’d expect to sell them at a higher price in the future.
Then, there’s what’s known as dividends. This is where the company gives some of the profits back to shareholders in a (usually) quarterly payment. Some companies pay dividends and some don’t. It all depends on the company’s strategy – one business may prefer to put profits back into growing while others pay profits back. I’ll talk more about what that means for you in part two of this series.
What to consider before you start investing
Before you jump ahead to placing your first trade, there are a few things you first need to consider.
Firstly, investing is really only appropriate if you have your financial foundations in place. This means having:
- a reliable and consistent income (or being able to manage inconsistencies);
- having a budget and knowing your living costs and available surplus cash flow;
- having an emergency fund of between 3 – 6 months of fixed expenses; and,
- being free of any consumer, credit card or other bad debt.
Secondly, you will need to consider how long you want to own the shares and the purpose of the money. As I said above, we’re talking here about buying shares to hold them for long-term wealth building. If you’re looking for somewhere to invest your house deposit, knowing you want to buy in a year or so, then the stock market may not be the right place for you. If you’re happy to take the risk of the value going down, or having to wait a few more years to reach your goal, then it may be entirely appropriate. Generally, the recommended time period for investing in shares is at least 3 – 5 years.
That leads us to a discussion about risk. The difficultly with risk is that it’s hard to predict how we will feel when our investments fluctuate in value. Most of us think we’d be more chill than what we end up being (especially if that investment is for an emotional purchase). It can be useful to use an online risk profiling tool to get a better idea of what that means for you. Shares do carry more risk than say putting your money in a bank account. This is because they have the potential to drop in value. Being a lower risk tolerance, however, does not mean you can’t buy shares. It just means that there are considerations for how and what you invest in.
Your risk tolerance is the main driver of your asset allocation. While this sounds complicated, it’s really just about how much you allocate to each different type of asset class (group of investments). Generally, these asset classes are grouped as follows:
Asset classes are grouped based on their similar risk and return characteristics. For example, while there are different types of fixed income assets they are mostly characterised by the fact they pay a regular and agreed cash payment to the holder. They also have similar security seniority, which is an indication as to the priority of repayment to the holder if the issuer goes broke (i.e. bondholders will be repaid before shareholders), which is a major indicator of risk.
As well as how variable an asset’s price is (volatility), the form of return is also important. Do you need your investment to pay a regular income (i.e. from coupons or dividends)? Or do you want price growth? Or maybe a mixture of both? The purpose of the investment, risk tolerance and your tax situation will all affect what percentage of your overall portfolio is allocated to each asset class.
Your asset allocation does not only affect your risk based on how much of a ‘risky’ asset you hold but also how each of the asset classes interacts with each other to affect risk. Having a range of non-correlated assets will help to minimise overall portfolio risk. This is known as diversification and should be done on both the asset class, industry and individual asset level.
As you can see, it’s important that you are clear on your strategic (long-term) asset allocation before you get started.
Finally, before you look at what to buy, think about any social, ethical or sustainability considerations you have personally. It’s important to invest in a way that is in line with your own personal values. Money is power. And we have the power to invest in a way that improves the world rather than simply make money at any cost.
In the next post in this series, I will be covering the ‘what’ of buying shares for your portfolio. You can check that out here.
*The 30-year average cash rate in Australia is about 4%.