A huge proportion of posts in the personal finance blogosphere are devoted to giving or asking for advice on what people should invest in, but I often feel like this is missing the point in some ways. This is simply because if you are planning on retiring even remotely early, the bulk of your wealth will actually come from savings rather than investment returns, and the choice of investment then becomes much less relevant, provided that you don’t invest it in things that go down the toilet.
Even so, you have to invest it in something (if you don’t want to just leave it in cash and get a pitiful return that doesn’t even keep up with inflation), which means that even for people that realise the (in my opinion) greater importance of your savings rate, how you invest your cash is still something you need to investigate and decide on.
Now I have written in the past about my dislike of managed funds / mutual funds based on my time working on the inside of that industry in London in 2008-2009, but I have never really given an overview of what I like to invest in and why. Many of you may not even care what I invest in personally, but I thought I would outline some basics about my investment approach and my rationale for it.
But first, some context about what I have invested in in the past…
Managed funds / mutual funds
My first ever investment was in a Colonial First State managed fund in Australia as an 18 year old. From memory I had about $2,000 (which I considered to be a sizeable sum) that I accumulated over about 12 months, and on the advice of a financial planner at work, I put it into this managed fund and made ongoing contributions each month.
I really can’t recall how long I had it in there, but I clearly recall the effect of the September 11, 2011 terrorist attacks on this investment – it declined in value by about 50% in the space of a couple of days. Here I was thinking it was a a fine start to my investing career, but thankfully I held in there and it had recovered just about all of the value in no time at all (maybe it was a couple of months?).
This didn’t seem like such a bad investment over all (the terrorist attacks affected any market-linked investment), but what I didn’t realise at the time was that I was paying fees and commissions through the nose for the whole investment. I wasn’t in it long enough for there to be any real investment returns since I took the cash out shortly after it had recovered its value to buy my first property…
At the age of 20 I bought my first property, a two bedroom unit. I lived in the unit for a year before selling it for a 34% gross gain. This was when Australia’s property market was going through a huge boom in the early 2000s, and while I made money, it was a result of luck rather than skill. Yes, I had assessed the property based on its financials (if I had rented it out it would have been a great rental yield of over 10% per annum), but there were lots of properties around with those figures in those days.
I took the money I made off that property, and then invested it into another two units, one of which made a great gain (58%), while the other made hardly anything (9%). While my real estate investing career may look pretty good, it is worth noting a number of key points that really took the shine off these returns:
- I sold the first property too early – I saw the same property advertised for sale about five years later for what would have been a 123% gain on my purchase price.
- The second property saw a great increase in value over the first 12 months, after which we bought our current house (using some of the equity that I refinanced out of it), but after that its value declined again slightly over the next seven years. In that remaining time I had a string of disastrous tenants, including one that left sex toys out on the dresser in plain view when the agent was doing a routine inspection, and someone who ran a small-time drug dealing outfit from the property. Admittedly it wasn’t in an amazing part of town so I shouldn’t have been surprised. With all of the tenant problems came additional costs (repairs, tribunal fees, etc) and also periods of no rent with it being vacant (couldn’t find a decent tenant), and so I gave back a lot of my return in the years where I was significantly out of pocket just to hold onto the property.
- The third property never really had disastrous tenants, but I had to replace the carpet, paint the place, install new heating and also deal with a couple of periods of extended vacancy. It was also very hard to sell in a quiet market (it must have taken six months or more). I had it revalued after about six months when we bought our house, but in the 7-8 years after that, it actually declined in value by about 15%.
While I had a long love affair with property, I believe that people often just look at the headline returns rather than the overall picture. By the time you take into account the costs of buying and selling, and also the costs of holding the property (give that most cost more to hold than they generate in rent), outside of short sharp boom times I am not convinced that property is a great investment. And if you add in the fact that it can be very illiquid, it really doesn’t stack up well in my view.
If however you have a decent amount of capital, and don’t need to leverage yourself so far just to hold the property in the first place, then property can be a decent investment overall.
Australians have been obsessed with property for many years, with a huge increase in the number of “Mum and Dad investors” in the last two to three decades, but if they fully understood how the investment really stacks up against others I am sure that they wouldn’t look on property with such affection. I believe that many invest in it because they believe that it is easy to understand, which it is at a simple level, but like many things that seem simple at first, there is a danger that your simplistic views, if not reassessed, become inaccurate over time.
I believe that “Mum and Dad investors” also love property because they feel that they can make “do it yourself” or DIY improvements to the property to add value. While it is possible to achieve this, many of these DIY improvements are poorly thought out and don’t result in an increase in value over and above the amount spent. In some cases, they actually reduce the value of the property, making them a complete waste of time. Others also confuse the reason for capital growth, sometimes thinking that it was a result of their improvements, when it was just a case of the market rising for all properties.
Why I invest in direct shares (stocks) and how I go about it
So now that I have given you that background, it hopefully gives some context for why I prefer to invest in direct shares, where I pick the shares that I buy based on my own basic parameters.
What are these parameters you ask? Well it’s a combination of objective and subjective, with the main criteria being as follows:
- The company must be “blue chip”, and in the top 50 stocks on the Australian market. This is because I am not trying to double my money overnight – I just want to make a decent return over time.
- The company must be listed on the Australian market – I am not interested in dealing with foreign currency risk, nor am I interested in paying the fees that foreign currency transactions attract.
- The company must have a strong history of paying decent fully franked dividends (i.e. preferably more than 4% per annum plus franking credits). Some companies pay pitiful dividends, and then you often find that they have pitiful growth to go with it. I figure that if the market takes a dive, the dividends usually continue (for the big companies anyway), so you don’t care that much about fluctuations in the market over the short term. If you’re relying on capital growth for most of your return, then you care a lot more about short term fluctuations in the market.
- I prefer big companies that have been around a long time, but have had their valuations smashed for a reason that I consider to be an overreaction – it’s surprising how often this happens.
- The company must be relatively simple to understand, and have a decent earnings outlook. This means nothing too high-tech, and sometimes downright boring actually.
- I diversify, but not too much. This means that I want to spread risk, but I don’t deliberately try to invest in every industry, and I don’t believe you can gain anything more from having say 50 stocks than from having say 20 stocks. Having 50 stocks just makes it much harder to keep your accounting/taxation records and do your tax return every year.
- I buy a stock to hold it, rather than trade it. I have no interest in trading.
- A lot of the above points happen to be quite similar to the investment strategy of Jason from Dividend Mantra. Pure coincidence, but he’s onto a good thing, so perhaps it’s a case of great minds thinking alike?
I prefer to invest in shares/stocks over other investments for many reasons, including:
- They are very liquid investments – I can buy and sell them at any time within about five minutes.
- The market fluctuates wildly based on the emotions of people and information that is often largely irrelevant. This creates buying opportunities.
- In Australia they pay franked dividends, which is a funny system where they come with tax credits that can work out very well for you if you plan things right.
- I am not scared of fluctuations in the market – I know that I will usually be holding the investment for quite some time so am happy to invest for the long term.
- When the market drops, I just see this as a buying opportunity. So in a way, I welcome dips in the market.
- There are no middle men – aside from brokerage of $19.95 per transaction, I don’t have to pay anyone for this strategy. There are no commissions, no taxes (aside from income/capital gains taxes), no advisers, no financial planners. Being a finance professional myself, I know that many advisers just regurgitate what others say, so I figure that there is little point in paying them for this.
So how have we done so far?
Pretty well I think. We have achieved very strong capital growth in our self-managed superannuation fund (where we invest in direct shares/stocks), as well as strong dividends, over the last eight years.
While we have invested for far less time in my wife’s name (after we paid off our mortgage), we are up by quite a decent percentage, and are consistently receiving a more than 5% return in fully franked dividends. Every month when I get paid, I just keep investing, and while I watch the market every day, I do it because I am interested rather than fearful a crash. It’s a real hobby of mine, but I don’t know anyone else that actually shares my hobby (not even my wife, even though she owns all of the shares!).
So what about you? Do you invest in direct shares / stocks? Or do you have a different theory on where to invest?