A guide to Australian Stocks for beginner investors; An anonymous guest post on getting started investing in shares in Australia.
What actually are stocks?
A stock or share is part ownership in a company. Suppose you start your own company. You own 100% of it. You start a company with a business partner. You own 50% of it. You buy a bunch of shares in Commonwealth Bank. You own something like 0.0001% of it, and although you probably won’t get much say about how the company is managed you are entitled to a cut of the profit!
Cool, so do you buy shares directly from the company and then sell them back?
Not quite. Companies generally go public because they want to raise capital (i.e. “if we sell half the company for $100,000,000, we’ll have all that money to grow the business and we’ll all get rich”). When companies do this they conduct an Initial Public Offering (IPO), which is a separate topic. Shares on the stock market are brought and sold by individuals (or larger investment companies, more on that later), much like if if you own some fruit you can take it to the market and sell it to me for a price you decide to sell it for and I am willing to pay.
When you see the share price, that is simply the most recent price that a share or group of shares was sold at. If a lot of people are trying to buy shares, that price moves upwards, and if a lot of people are selling the price moves downwards (think supply and demand). When people talk about how ‘the market’ going up or down and point to a graph, they are generally referring to the movement of share prices in an index (i.e. a collection of companies) such as the All Ordinaries (the top 500 listed companies in Australia), Dow Jones (30 large companies listed in the USA) or the S&P 500 (500 large companies listed in the USA).
Hang on. So the share price has nothing to do with the actual company and everything to do with what investors are willing to pay for it?
Pretty much. This is what it means when people talk about picking up a bargain, or a particular stock being overpriced. In the 2008 Global Financial Crisis when the market essentially halved in price, it wasn’t as though the biggest companies in the world literally halved in value. People just rushed for the door and tried to offload their shares, which drove the price down.
Speaking of that, what there is another crash? Can’t I lose all my money?
In theory, yes. If you invest in an individual company, and that company goes under, you would lose your money. But suppose you invested in all the top 200 companies in Australia (more on that later). For your investment to go to zero, Commbank, Westpac, NAB, ANZ, Woolworths, Coles, Telstra, BHP and all the other major companies you have heard of would have to go under (in which case your investment would be the least of your worries). Realistically it is never going to happen.
Statistically, 3 out of every 4 years the market goes up in price, and 1 in every 4 years it goes down. Once every decade or so there is generally a big crash, with smaller ones every few years. This is just a normal part of the market cycle. The market has always trended upwards in the long term (at least in developed countries such as Australia) and is almost certainly going to continue doing so. However, in the short term, things can be unpredictable. It would be unwise, for example, to invest money you are planning in using for a house deposit within the next few years.
What companies can I invest in?
Pretty much any listed on the Australian Stock Exchange (ASX). There are ways of investing in individual companies listed in other countries. But we’ll discuss that another time.
In the past few decades, Exchange Traded Funds (ETFs) have become very popular. These are essentially just a bucket containing shares in multiple companies. These are a great way to diversify (i.e. not put all your eggs in one basket) as well as getting international exposure. Some popular ETFs are Vanguard Australian Shares (VAS) which contains the top 300 companies in Australia and Vanguard International Shares (VGS) which contains thousands of the biggest companies around the world, excluding Australia. There are ETFs for almost everything from Ethical Investments to India to water companies to eSports companies to corn to pharmaceuticals and everything in between.
You can also invest in a Listed Investment Company (LIC), which is a company that hires active fund managers to pick stocks and build a portfolio that they believe will perform better than the market average (some of these include AFIC and ARGO, which from memory are mentioned in The Barefoot Investor).
There is an ongoing debate on whether ETFs or LICs are the better investment. I think either is fine as picking individual stocks yourself is a tricky game, however, ETFs generally have lower fees and have on average performed just as well as managed funds, if not better.
Isn’t now a terrible time to buy though? I’ve heard the market is at an all-time high! And isn’t there a recession coming?
Historically the market has always trended upwards – there have regularly been all-time highs!
There will likely be a recession in the next few years, but nobody knows. It may be tomorrow. It may be next year. It may be in 5 years. By the time it happens, the market may never go lower than where it is currently at. I don’t know, you don’t know, the financial media has been talking about it for years and will act like Nostradamus when it finally happens, but they don’t know either.
If you are investing in ETFs for the long term, TIME IN THE MARKET is more important than TIMING THE MARKET. A very popular strategy is Dollar Cost Averaging (DCA), by which you invest a little bit at regular intervals (for example $5000 every 3 months). This means you invest during lows as well as the highs, and your entry price gets averaged out.
For a far better explanation, check out this infographic: https://www.personalfinanceclub.com/how-to-perfectly-time-the-market/
What are dividends?
As you are the part-owner of a company, you are entitled to a cut of the profits. Companies generally try to reinvest profits into things like marketing, research and development, expansion and generally trying to grow the company. However sometimes if the company is very big already it may have some profits leftover and decide that they are better off paid out to the owners instead. That is a dividend.
There is a fair bit of nuance to this, but here is the gist. The company you part own makes a bunch of profit, which that company, and by extension, you as an owner, pays tax on (you won’t literally see it in your tax bill, but just hold that thought for a second). As a part-owner, you are paid some of the profits as a dividend, which you also have to pay tax on… what kind of shenanigans is this? Having to pay tax twice?!? Suppose a company pays 30% tax on its earnings. You receive a $100 gross dividend as a $70 dividend with a $30 franking credit. Come tax time you would need to pay tax on the $100 gross dividend. If you are in the lowest tax bracket and your marginal tax rate was 0%, you would be refunded the entire $30 that the company already paid (this is why franking credits are so popular with retirees). If your tax rate was 45%, you would only have to pay $15 for the $100 dividend (as the company has already paid the $30). leaving you with $55 total.
What are bonds?
Bonds are basically a loan to a company or government. You lend X amount of money for Y amount of years and get paid a yearly interest payment (known as the coupon) of Z. You get your money back at the end of the time period when the bond reaches maturity, or when you sell the loan to somebody else.
Bonds are generally considered defensive investments, as they tend to maintain their value during economic downturns and are good for retirees or people who already have a large base of wealth and want to maintain it while living off the coupon rather than taking on the high risk (in the short term) high reward (in the long term) of the stock market.
How do I buy shares?
You can buy shares through online brokers such as Commsec, Commsec Pocket, NABTrade or SelfWealth. Commsec pocket is a great place to start as you can buy smaller amounts with relatively low brokerage (i.e. the fee to purchase shares). This is a good way to put a little bit of money into the market, dip your toes in the water and see how it all works.
The downside of Commsec pocket is that you are limited to 7 ETFs to purchase. In the long term, you may wish to use another broker which is more economical for investing larger amounts and offers a greater number of investment options.
Captain FI’s closing remarks
Well that was a great beginners intro into what the share market is and buying stocks in Australia for beginner investors! Now this post was actually written about three months ago and has been sitting in my inbox, it turned out to be sage advice about expecting a recession! Although no one can really predict market crashes.
If your thinking about getting started investing, have a read of the following articles on investing here. I discuss everything from Asset classes (including the old Stocks v Property debate), to Franking credits, portfolio management tools and Safe withdrawal rates.
One of the best tools I have on this website is a review of all of the ETFs and LICs I invest in. Check them out and see whether they are the right investment for you
- Betashares Australian top 200 index fund (ASX:A200) MER = .07%
- Vanguard Australian shares top 300 (ASX:VAS) MER = .10%
- Vanguard Total US Market (ASX:VTS) MER =.03%
- Blackrock iShares S&P 500 ETF Total US market (ASX:IVV) MER = .04%
- Vanguard Total world ex US (VAS:VEU) MER = .09%