Anyone following Australia’s general news reports will quickly come to realize that one aspect of Australia’s financial health above all others is followed with slave-like devotion. Yes, I’m referring to the share market.
As our share market fluctuates daily, sometimes ticking up, sometimes plunging precipitously down, its every move is watched, scrutinised and commentated on with all the fervour of a national sport.
For many new investors, the share market together with Exchange Traded Funds (ETFs), are exotic beasts in a financial zoo. They are little understood, mysterious, forbidding, occasionally intimidating and potentially difficult to tame. However, new investors should take heart, the share market is a great opportunity to take that first step towards starting to making your money work for you!
While many liken the share market to a casino with all a casino’s potential for financial disaster, the share market remains one of the best types of investment if you are looking to build wealth over time.
Every dollar you invest in shares begins working for you, hopefully generating dividend income and capital gains. Ideally, you can then reinvest your dividends in more shares, thereby accelerating your wealth creation momentum.
A share is the basic unit of ownership in a company. Owning a share of a company’s stock makes you a part owner of that company. Share ownership gives you voting rights on board elections and other issues. If the company pays a dividend to shareholders, you receive a pro-rate amount for each share you hold.
When that company makes a profit, they reinvest that revenue in the company enabling it to grow over time, further increasing the value of its share price. Some of that profit is distributed to the company’s shareholders in the form of dividends. These dividends are typically distributed to shareholders either twice a year or quarterly.
Many companies offer dividend reinvestment schemes whereby you can reinvest your dividend in additional shares, further growing your wealth over time.
The Share Market And Risk
If you track the share market for any period of time, you quickly realize the value of individual shares and the share market as a whole can vary significantly from day to day.
While there is some volatility attached to the share market, it is usually driven by a host of economic indicators as wells market sentiment. The quest is then, “How can you possibly make money if you are buying a share in the hope that its value will increase over time?”
In the short term, risk usually takes the form of a one-off piece of news or market update. Daily share prices are determined largely market sentiment and the emotion of investors manifesting itself in the market as they try to value individual shares or industrial sectors on a daily basis.
A more accurate representation of share market value is the underlying long-term trend, as the intrinsic value of a company, represented by the sum of its products or services, customer base, distribution network and assets rarely changes radically from day to day.
Speculators and day traders try to buy cheap and sell high to churn their shareholding to take advantage of “market timing.” For most investors, this approach is a fabulous way to lose money on shares.
In the long-term, much of the short-term market noise disappears and investors come to appreciate the long-term financial returns from investing in shares.
Index Funds are a low fee passive investment fund that spreads its risk across a range of shares in a particular market. If a fund targets the ASX300 it will buy a basket of shares from leading stocks listed in that Index. That means owning a bundle of shares in Australia’s 300 largest companies by share value. This represents approximately 85 percent of Australia’s total share market!
Using this investment strategy, you get the average return experienced by the overall market. An Index often outperforms more active managed funds and the fees you pay to invest in an Index Fund are comparatively modest.
How To Buy Into An Index Fund
You can buy an Index Fund directly from their website or you can buy through a registered share broker. Each trade with a share broker attracts a brokerage fee. There are many options so shop around to find an option you are comfortable with in terms of its fees and service,
The concept revolves around gradually and consistently buying into the market, regardless of the share price. However, don’t dip into the market so frequently you begin to chew through your investment funds in brokerage fees.
What About International ETFs?
ETFs or exchange-traded funds are effectively mutual funds traded on a stock exchange. As with conventional stocks, they have their own ticker symbol and their prices are quoted moment-to-moment.
ETFs are an increasingly popular option for smaller investors. Low entry costs and a wide range of investment options represent much of the attraction of ETFs as investments.
Investing in an international ETF enables you to diversify the geographical risk of your share portfolio without making your investment life too complicated. With the Australian market representing just 2 percent of the total world’s shares, it is sensible to broaden your exposure to overseas stocks.
Buying Or Selling ETFs
Buying or selling an ETF is simple and straightforward. You trade through a stockbroker who charges investors a commission on each transaction.
Earning Income From ETFs
Generating an income from ETFs is similar to investing in mutual funds as they work in almost identical fashion. As with mutual funds, your ETF holds different types of investments. The ETF can invest in a range of items, including stocks, bonds, commodities (gold, silver), or an index such as The Dow Jones Industrial Average or the S&P 500.
As with most form of investments, the profits you earn from an ETF hinge on the performance of the ETFs underlying investments over time.
So, if you invest in an ETF targeting shares with a track record of paying out high dividends, you have the opportunity to benefit from both a dividend income stream generated by the dividends paid to your ETF by its share investments and a nice capital gain. Similarly, if you invest in a bond-focused ETF you are looking to benefit solely from its interest income.
What If Australia’s Share Market Collapses Tomorrow!
The market may crash tomorrow or the day after, or the day after that and your shares may drop in value. However, remember to focus on long-term value rather than short-term price movements.
Providing the basic nature of a business remains undiminished by a crash, the share market should ultimately correct itself. Many analysts point out that a market crash is a great opportunity to buy in at a lower entry cost.
Despite their ups and downs, the share market remains one of the main paths to becoming gradually rich. By putting in place an investment strategy, which reflects your appetite for risk and harnessing the power of shareholder ownership both locally and internationally via ETFs you can get your money working effectively for you.