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Money Makeover - Part 3

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Which is the best way to build your wealth? Shares or property?

In the last step, I looked at ways to build your wealth using good old bricks and mortar. Now I want to put the spotlight on this asset’s mortal enemy – shares!

The eternal battle

In stockbroker or financial adviser circles, there’s an age-old battle between which asset class is the best to make yourself richer.

I have studied Aussie property and shares relying on work done by Rod Cornish, head of property research at Macquarie Bank, and in a head-to-head battle over five-, 10-, 15- and 20-year periods, both asset classes returned 10 to 12 per cent, on average, per year, over these time periods.

Sometimes shares won. At other times, property did.

The dark side of property

The critics on both sides, especially shares, always like to point out the problems with property. These include:

• Tenants’ issues
• Agents’ issues
• Maintenance
• Rates
• Insurance.

The dark side of shares

On the other hand, houses don’t disappear as easily as Babcock & Brown shares. Take your rental property – it, for example, does not lose 50 per cent in value or more as shares did in 2008-09.

The bright side of bricks and mortar

The best argument for property being better than shares is given to you by the banks. Simply put, you can borrow more from a bank for property than you can for shares. Okay, property is safer but it might not give you better returns.

Switzer’s view

I like both assets and I hold both. When I was young, I was big on bricks and mortar and did well, but I wish I had bought BHP-Billiton at $10 or even lower.

Similarly, CBA when it was in single-digit figures was a sensational buy and asset to hold.

My preference for novice share players is to encourage them to buy great name companies that have a history of paying dividends.

In fact, half of the long-run return from shares comes from dividends and that’s why I like holding lots of shares that cough up solid dividends.

The dogs strategy

The Yanks have a cute share-buying strategy called the ‘Dogs of the Dow’. I was reminded of these as I am writing this piece from New York, where I am catching up with the guys from Fox Business.

These are the 10 highest yielding stocks in the Dow Jones Index, which only has 30 stocks, but they are the top 30 stocks in the country. The theory suggests that as dividends are more stable than stock prices, a high dividend yield says a stock is near the bottom of its business cycle and the share price is down but will soon head up. An equal amount of money is put into each of the 10 stocks. There are variations on this ‘Dog’ play but this will do for now.

By the way, the strategy has not worked in the past couple of years but it has done pretty well in the past.

What shares do you buy?

In terms of what shares to buy, you can get a stockbroker to make you a portfolio which will reflect your appetite for risk. You could get a model portfolio from websites such as CommSec or you could buy an ETF (electronic traded fund) that approximates the S&P/ASX 200.

So, if the market is up two per cent, your investment is up very close to that as well.

Some people might buy the top 20 stocks or the top 20 dividend paying stocks and just hold them, no matter what. These all have their critics and supporters but most of them are better than picking stocks on a hunch, a newspaper article or a tip from a mate. In most portfolios of assets put together by advisers, shares usually attract 60 to 75 per cent of the money, property might get 15 to 20 per cent and cash or fixed interest the leftover bits.

Some critics say advisers, however, are biased towards shares because it’s easier for them to make more money out of recommending shares than property.

Shares are a good investment if you buy quality, and play the waiting game.

Tip: It’s a marathon, not a sprint! Buy quality shares, invest long term and remember, it’s about your time in the market, rather than timing the market.

In the previous two chapters of my money makeover, I looked at getting your hard-earned money into property and shares. Now comes the boring wealth spinner – bonds, fixed interest and cash.

The professionals will look at these three asset classes as being different investment alternatives, but to normal people, they do have common links, their returns are dependent on interest rates and they are pretty damn safe! And it is because of their relative safety that their returns seem less than exciting.

History tells the story

Let’s look at recent history to support this unfair criticism of boring bonds and bank fixed interest deposits.

Before the crash of 2008-09, the stock market peeled off five years of double-digit growth and, for four of them, the overall index rose over 20 per cent.

Now, generally when it comes to fixed interest you work off getting around four to five per cent but when the ‘you-know-what’ hit the fan in 2008, banks were offering seven to eight per cent for fixed deposit money.

The trade off always happens

This was a perfect time for cashed up and job-secure investors to slam money into fixed deposits for as long a time as possible.

Of course, if you put too much into such a deposit, you would have missed the 50 per cent or so rise in the stock market from March 2009, and that’s another good case for never putting all your eggs in one basket.

Imagine you were a regular saver/investor and you decided to put:
• 60 per cent of your savings into shares
• 20 per cent into property
• 15 per cent into fixed deposits
• Five per cent into cash.

If you did this, you’d now be earning seven to eight per cent on your fixed deposits when most Aussies would be lucky to get six per cent. Others might have locked up their money at five per cent three years ago.

Always a gamble

The time when you actually fix is always a gamble but when rates climb over five or six per cent, especially after inflation is taken out, then stock markets often wobble and returns fall.

Investors are always thinking: “What will I get in the risky stock market compared to the safe fixed interest/bond market?” And if the returns get close, then there’s a rush to safety pushing stock prices down.

Safe but …

Government bonds are the safest but they don’t return great yields, and small players can’t access them in Australia. Our corporate bond market is not like America’s, where you can buy less safe bonds in companies, but there are some products now emerging in our markets, which means you can lend money to well-known companies such as Telstra.

Investment groups such as Vanguard have bond funds and these can do really well over the long run. These guys mainly invest in safe bonds but they do speculate in the corporate bond market and this can bump up their returns.

Shares versus bonds

Depending on what time period you look at, shares often beat bonds for returns but sometimes it can be the reverse – even for a pretty long time.

These bond plays can be called boring but this might be an unfair tag given that shares can sometimes have complete shockers like we saw over 2008 and early 2009.

In fact, in the US, the Dow Jones at its 10,520-level near the end of 2009 was no higher than it was in 1999! It actually is lower if you adjust this for inflation, which means bonds would have been a better play for most Americans over the past 10 years!

Tip: To find the investment strategy that best fits you, seek guidance you can trust — contact a reputable financial adviser (more on this in step 11!)

When it comes to success on the share market, diversification is the name of the game.

The Wall Street Journal and The New York Times recently looked at the performance of shares over the past decade. The themes of their stories were that shares had under-performed pretty badly. However, incomplete pictures were put into focus with these snapshots.

Only thrill seekers need apply

Collectively, these articles told any reader that if you are a thrill seeker, who won’t whinge if you lose your investment by being only in shares, then you don’t have to be a diversified investor. Most of us don’t fall into this category.

Switzer in the Big Apple

When I was in New York perusing The Wall Street Journal, I read that the poor old American share investor had copped a decade of negative returns from shares! But the bad story became even worse when you threw in an adjustment for inflation.

At the time, the Dow Jones Industrial Average was at 10,502.10, which it also was in 1999. Ten years had passed and the index was no higher but once you put today’s level into 1999 dollars, the Dow would have to be at 13,460 to break even!

Think again

Taking a different look at the share situation 2000-2009 – the noughties, if you like, where the return was in the nought region – The New York Times suggested we think again.

For the shares obsessed

If you use the Vanguard index for the S&P 500 index of US shares, $100,000 invested on 1 January 2000 would have shrunk to $89,072 by mid-December 2009. Adjusted for inflation, it ends up being $69,114. But this would be the sad story of a shares-only investor.

Why it pays to diversify

The diversified investors did a lot better.

If someone put $50,000 in Vanguard’s Total Stock Market Index Fund and $50,000 in Vanguard’s Total International Stock Index Fund, the $100,000 would now be $109,334, but with inflationadjustment that goes to $84,921.

Now let’s get more diversified

With $25,000 in each of the above share funds and $50,000 in Vanguard’s Total Bond Market Index Fund and the starting $100,000 grows to $145,619 and $112,971 with inflation thrown in.

If you diversify

Now this was a decade for Americans where they had two recessions and two market crashes – the tech bust of 2001 and the 2007-09 crash. The result was not bad for the diversified investor.

The New York Times also showed what happened to someone who put a $1000 a month into these three investments, rebalancing each year to keep the break down of 25 per cent in US shares, 25 per cent in overseas shares and 50 per cent in bonds.

This person would have invested $220,000 over that time, but this grew to $313,747 or $260,102 when inflation is factored in.

Aussie share performance better

By the way, in Australia, we did a lot better out of shares over the decade.

While the Yanks lost 1.3 per cent, our market grew by 12.7 per cent, which was the best of the Western stock markets.

Apologies to Warren Buffett

I’m an absolute fan of Warren Buffett but he has been reported as saying that “diversification is for wimps”. While he might be right, that’s the way I like to invest my money … and other people’s money!

Why advice is important

Also this story shows the value of rebalancing a portfolio and is one of the many services a good and trustworthy financial planner should do for you, if you can’t do it yourself.

Click here to view Money Makeover - Part 2. Steps eleven and twelve will be available in the next edition of Switzer News. You can also download the full eBook on the link below.


Published on: Friday, January 04, 2013

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