Share star...Lexie Petroff trusts her ears and her instincts when investing. Photo: Simon O'Dwyer
In the final instalment of a three-part series, Bina Brown recommends sticking to some simple rules when investing.
Whether it is through a share club, a stockbroker, a financial adviser or reading books, there is nothing more valuable than knowledge when it comes to understanding the sharemarket.
There are some basic truisms that you will repeatedly come across, such as: don't put all your eggs in one basket and it is time in the market, not timing. While the temptation might be there to invest heavily in one company at the expense of any others, or put everything in the sharemarket while ignoring other asset classes, it is not a sound strategy.
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Diversification reduces risk. Diversification can be quite broad, where you invest some money in shares, property and cash. In the event one of these asset classes declines, you have not lost everything. A diversified share portfolio might be one that includes investments in sectors, including banking and finance, media, health and resources. Diversification generally means a lower level of volatility and higher long-term return.
Then there is that saying: It is the time in the market - not timing the market. It has been repeatedly proven that all shares have their troughs and peaks but, with great companies, the peaks are generally significantly stronger than the troughs.
If there is a downturn or correction in the market, it is important investors don't panic and realise their losses at the worst time. Nor would they want to be out of the market when the market bounces back.
Dollar-cost averaging sits well with timing. It is human nature to sell things when times are bad (so things are cheap) and buy when times are good (usually more expensive).
Essentially, if you decide to invest $1000 twice a year in one company, assuming the shares rise and fall in that time, you will end up buying the most shares when they are at their lowest price and the least shares when they are at their highest.
Portfolio construction
A Prescott Securities private client adviser, Ben Prisk, says diversification of stocks is an important component in portfolio construction. However, the risk reduction benefit is less with each share added to a portfolio, he says.
"Given most share investors are trying to outperform the return of the broader All Ordinaries sharemarket index, some level of risk by way of establishing concentrated positions is good," Prisk says.
He says that depending on the amount of money someone has to invest, on average the target is for 10 to 20 stocks across a portfolio, where the benefits of diversification are not outweighed by the added complications.
He says it is often a temptation to keep acquiring new stock positions across a portfolio without assessing the broader merits of doing so. It might be time for some hard decisions.
Prisk says investors should be prepared to take a profit on a particular stock or possibly crystallise a loss if they see a better buying opportunity. "Whilst it is psychologically difficult to sell investments at a loss, if you can't establish an earnings catalyst for a particular company in the foreseeable future, the disposal and subsequent repositioning of the investment can deliver improved performance to your portfolio," he says.
Gearing
Going into debt to buy shares will not be for everyone but those who are happy to borrow money might consider two options.
The first is a margin loan, using the shares as security against a loan. If the value of the shares falls, an investor may have to either sell some shares to reduce the loan-to-valuation ratio or find some more cash.
Another, generally cheaper, option is to use existing equity in your home.
Hans Kunnen, a respected market economist, author and former head of investment markets research at Colonial First State, says borrowing to buy shares is like borrowing to buy an investment property but is less risky, has less paperwork and you can start with less money.
"Dividends pay off interest costs over time, your loan is tax deductible and dividends come with a large part of their tax already paid," Kunnen says. "Borrowing to buy shares is all about patience and cash flows. It is not about getting rich overnight. Good-quality, dividend-paying companies have seen their dividends rise over time and will see further growth as the Australian economy expands."
Keeping a finger on the pulse
TWO-TIME winner of the Bayside Shares Investor Award, Lexie Petroff, uses her own instincts to select the companies in which she is going to invest.
"I read newspapers and follow the news and generally watch what the community is saying and doing," says the Melbourne-based naturopath. Using this simple formula Lexie sold her shares at the start of the global financial crisis at a high.
She is now back in the market, following the same logic, although not as intensely as before the market crashed.
Being a naturopath she decided to invest in natural health care provider Blackmores.
"Last year I thought because things were starting to slow down people would be looking for bargains so I invested in The Reject Shop," she says. Her award was for investing a hypothetical $120,000 to pick the best performing portfolio of six stocks in 2010.
Her picks also included Blackmores and Cochlear. Lexie joined the Bayside Blue Chip Share Society — one of several share clubs operating around the country — in about 2006 and continues to meet regularly with a group of investors to discuss shares and listen to sharemarket professionals. "It is a very worthwhile opportunity to meet others who are interested in shares and discuss what is going on in the economy," she says.
The founder of the society, Gavin Adamson, says that while the society is blue chip by nature, many of its members hold a combination of blue-chip, mid-cap and speculative shares in their portfolios.
