Play the market: tips for the first-time investor
With the stock market in much lower territory, it must be getting close to the time when novices who want to get into shares might want to think about how they should approach it.
There are lots of ways to buy into shares, but I think it gets down to two major ways: the right way and the wrong way.
The starting point is to know what you are trying to achieve. For example, if you want to get rich quick via shares then there’s a good chance you will fail and lose a lot of money.
However, it could happen, but you might need a good dash of luck along with some very good stock pickers. Oh yes, you’ll probably need debt, which can be the key reason you might succeed or fail big time.
If your goal is to gradually become wealthier then you are starting with the right goal.
In a nutshell, you should strive to have a portfolio of 10 or, even better still, 20 stocks. If you have 10 stocks each one gives you a 10 per cent chance of helping or hindering your portfolio’s advancement.
By having 20 stocks you are only vulnerable to one stock to the tune of five per cent.
A sensible goal is to try to make a 12 per cent return, which has been the approximate overall return for shares when you look at them on a long-term basis.
Selecting the top 20 stocks in the All Ordinaries or the S&P/ASX 200 index can be a way to get close to that kind of return.
Words of warning: there are no promises but only history on past share performances and the lawyers make us say that past performance is no guide for the future. That said, holding good blue chip shares has been the basis for many wealthy Aussies becoming exactly that – wealthy.
A reliable stockbroker can construct a portfolio, but they can do really well or have complete shockers. I think you need some blue chip stocks for a foundation and then maybe some smaller companies with some potential blue sky profits.
However, you have to be careful as brokers often charge one per cent on the portfolio to advise you. They win when you lose or win, so make sure they don’t try to over-service you.
Similarly, financial advisers who work out a percentage charge can end up overcharging you. Make sure you know the charges and also be certain that the adviser or broker is not making recommendations to line his or her pockets.
If you get a 10 per cent return on your portfolio then your wealth doubles every 7.2 years. How do I know that? It’s the Rule of 72! By dividing the percentage return into the number 72 it tells you how long it takes to double your money.
So if you manage to get 12 per cent then your money doubles every six years.
Let’s work through an example where you make your own selections based on the top 20 or top 30 stocks which you’d like to hold long-term.
Assume you had $50,000 to invest, then in six years you’d have $100,000 and by 12 years you would have $200,000 and so on.
To get richer quicker you might borrow to take your total portfolio size to $100,000. You might have $400,000 in 12 years and $800,000 by 18 years.
I am ignoring tax issues and interest rate costs, but these are important areas where you need to do homework. And homework is critical to buying shares properly.
My best advice is to approach the construction of a share portfolio to make you wealthy in the same way I advise people looking at buying a property. The approach is business-like. Create a step-by-step plan that will look at both the potential upside and the possible downside.
The upside is results better than 10 to 12 per cent. The downside is margin calls, a long recession undermining company results, and bad loans compounded by rising interest rates if you take a punt on borrowing to buy shares.
The name of this risk analysis game is cash flow management. If you had a safe job then income would be a low risk in building wealth. Interest rates, poor advice, inadequate research, dodgy advisers ripping you off for fees, and being a punter instead of an investor and wealth builder are all risks.
To successfully build wealth, you have to beat these risks.
A final word on not managing your costs and fees – imagine you earn nine per cent net on $100,000 invested. Your money doubles every eight years. After 24 years you have $800,000.
If you lose one per cent in fees, your nine per cent becomes eight per cent and your money doubles every nine years. You get to $800,000 three years later.
The summary is to pick great quality shares, with fee minimisation, clever interest rate plays and have tax nous. This is a great way to grow wealthy.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Published on: Thursday, December 01, 2011blog comments powered by Disqus