By Jason Fittler
One question I am often asked is how much I need to get started in the share market. My answer is “You only need commitment.”
When starting to invest you need to keep in mind that Financial Advisers generally get paid in line with the amount you are investing. As such they will spend more time with large investors. If you are a small investor this can be a barrier to entry into the market.
Do not take this as an insult but merely how business is done in all sectors of the market.
For example, try calling your bank these days, if you only have a savings account they want little to do with you, if you have a home loan then they show a bit more interest. Image if you were the CEO of BHP, I am sure you would have a team of people running after you.
You can however as a small investor arm yourself with some fundamental knowledge before having a meeting with a Financial Adviser. Below I will discuss some of the key issue you should be across as a small investor.
1. Buying direct shares? If you are looking to invest less than $100,000, direct shares are not a good long term strategy.
2. Borrowing to invest, for a small investor gearing is a great way to improve your overall return but you must also consider your cash flow when gearing.
3. Ongoing investments. As a small investor you will never get larger unless you commit to making further investments. All small investors should be making regular contributions to their investments at least monthly.
4. Putting off investing. It is and has always been, time to invest in the market. Make investing as much a part of your life as your birthday.
Let’s work through some examples.
First, excuses for not investing.
I will invest once I have;
• Paid off the house
• Brought a new car
• Gone on a holidays
• Kids are out of school
• Gotten older, I just want to have fun now
• Can afford it
To these people I say “Enjoy the age pension”, if you are working you should be investing, if not make sure you love your job because you will be doing it for a very long time.
Once you get pass the excuse stage, next issue is how you should invest.
If you have less than $100,000 to invest I do not recommend direct shares. The issue is diversification, for example if you have $10,000 invested in 10 different shares and you are chasing an 8% return being $8000 pa. If one of these shares were to fall over this would wipe out a full years return. I normally like to see at least 20 shares in a portfolio.
If you have less than $100,000 I recommend that you look to invest through a listed index fund or through a Self Funding Installment Warrant in a listed index fund to maximize the benefits of gearing.
When you start small there are two things which will help accelerate your return, gearing and regular contributions. First let’s take a look at gearing.
Let’s say you have $50,000 to invest, you are able to achieve a return of 10% or $5000 pa not bad. If you were to borrow another $50,000 and make your total investment $100,000 your return would be $10,000 less interest of $3,750 (interest rate of 7.5% on a $50,000 loan) giving you a return of $6,250 on your initial investment of $50,000 or 12.5%. This extra 2.5% will make a large difference over ten years, without gearing in ten years your portfolio is worth $130,000, with the gearing $162,000. This is a 24% improvement; gain is after loan has been paid out.
If you are young or making up for lost time gearing is a sensible strategy which should be fully explored.
Property verse shares, an age old battle.
When it comes to gearing, investors are much more willing to invest in property. They are also willing to gear up to 95% something you would never do with shares. Putting aside the issue of which is better when you are a small investor, there is a more important issue, one which is generally over looked.
Cash flow is very important to building a portfolio and especially if you have other commitments.
If buying an investment property and borrowing above 50% of the value of the property, the property will be cash flow negative. This means that the cost of interest, rates, insurance and repairs will be more then the rent you receive. As such you will have less money in your take home pay.
This lack of cash flow will indeed limit the funds available for other investments and most likely cramp your lifestyle.
When gearing through either a margin loan or Self Funding Installment Warrants this will not be the case as the income from your share portfolio will cover the costs, being interest.
Let’s take the above example and we invest $50,000 in Self Funding Installment Warrants SFIW, which is paying a yield of 6%. As SFIW are geared 50% and the interest rate is currently 7.5% the total interest expense is $3,750 ($50,000 @ 7.5%). The income on the investment is $6,000 ($100,000 @ 6%) as such there is no drain on your cash flow. This means that this will leave you more money to make further investments.
Nothing tells you more about a persons intentions then their ability to commit cash to achieve their dreams. Think about this in your personal life. There are a number of significant times when you have committed cash to your dreams;
1. Buying your first car to gain independence.
2. Paying your way through University to obtain a career.
3. Overseas travel to broaden your horizons.
4. Engagement ring to show her how important she really is. Not to mention the cost of the wedding.
5. Your first home to raise your family in and giving your kids security.
6. Salary sacrifice into super so you have a good retirement.
A cash commitment to your investments is the same thing. It shows the level of commitment you have to achieving financial freedom. Let's work the above example of investing $50,000, but this time we will add $500 per month into this investment.
With no gearing and a 10% return adding $500 per month, your investment after 10 years would be $225,000 or 73% more than not making a cash commitment. Add in the gearing and the value would be $270,000 or 66% more. If you maintained your gearing at 50% over this 10 year period, which means if each month you invested $500 you borrowed another $500 the value of the portfolio after the loan was paid out would be $560,000 a return of 330% above the initial investment.
Gearing works if used properly. Please also keep in mind I use the example of $50,000, you do not have to have this much. The principals are the same on smaller amount and the percentage returns are the same.
If you are a small investor you have real options which in as little as 10 years can turn you into a very large player.
Time waits for no one, if you would like advice on how to get started, give us a call on 07 4771 4577.