This article is an extract from Alan Hull’s latest book, Invest My Way
The word ‘Invest’ actually means to, ‘Apply or use money for profit’ which includes any money making endeavor which requires money. So to describe yourself as an investor could mean that you’ve had to spend money to start your own business, you’re a property investor or even a Tradesman who owns his own tools. Hence the tag, ‘Investor’ is not a very useful definition…
However the word ‘Trade’ means, ‘Buying and selling for profit’ which does make for a useful definition. If I say I am a share trader then I am stating that I buy and sell shares for a profit which sounds ridiculously simple but there are deeper implications to this statement. For instance, if I am buying shares with the intention to sell them at a future date for a profit then they must be rising in value. The funds management industry refer to this type of share as a ‘Growth stock’ because, hopefully, the share price will grow over time.
A share trader qualifies as a type of investor because they are applying money to the Stockmarket in order to generate a profit. Contrary to popular belief, a person who deals in shares is not defined as a ‘Trader’ by the number of trades they perform each year. This definition was created by a certain Government department and, whilst it may serve their purposes well, it is very misleading for the rest of us. If you purchase a share with the intention to sell it at anytime in the future for a profit then you are a share trader. The value of the share must go up over time and you could sell it after 1 week, 1 year, 10 years or even longer.
If we define a share investor as someone other than a share trader then I think it would be fairly sensible to view investors as ‘Asset managers’. So unlike a share trader who will sell shares that start to fall in value, investors will buy more shares because they represent a cheaper income stream. So a share trader wants to buy a rising share price and an Investor (read asset manager) wants to buy a high income yield which occurs when the share price falls…perfectly opposed objectives!
Furthermore as investors have no intention of selling, unless the income yield becomes unacceptable, one can safely assume that their preferred holding time is forever. And ‘forever’ just happens to be Warren Buffett’s favourite holding time as well…not really surprising as he’s very much an investor and not a trader.
- Assume that a company pays an annual dividend of $1.00 and the share price is $10.00
- Hence the dividend yield or income yield = $1.00 / $10.00 = 10% per annum.
- Now let’s assume the share price drops to $8.00 but the dividend remains at $1.00 p.a., a not unlikely occurrence given that a company’s profitability isn’t necessarily linked to its share price.
- Therefore the dividend yield would increase to = $1.00 / $8.00 = 12.5% per annum
So if you want to buy a high yielding stock, referred to by Fund Managers as an, ‘Income Stock’, then the direction of the share price is largely irrelevant because you don’t really have any intention of selling the share at a later date. In fact if the share price was to halve during a Stockmarket crash you would buy more shares because the yield will have doubled.
This is where ‘Dollar cost averaging’ is used very effectively because you keep buying more shares as the share price drops and the dividend yield keeps rising, thus averaging up your income. Hence dollar cost averaging is a very effective technique for investors…but not traders.
Now let’s turn our attention to real estate investment and look at how property can be either bought and sold for a profit or held as an income producing asset, just like shares. I’ll use a real world example here because recent developments in the property market will prove very illustrative.
As many property investors are aware there is a large population of baby boomers in Australia (and the world) who are nearing retirement. It has been broadly assumed that this particular demographic are going to sell up their family homes, once the children have vacated, and retire on masse to locations more suited to a leisurely lifestyle than the suburbs.
Hence the massive investment in, and development of, inner city apartments we’ve seen in Australia since the turn of the millennium. Now assume for a moment that you’re an investor who is currently in possession of an inner city dwelling and you have to make a command decision as to whether you should retain the property for the rental income or sell it outright for a profit. Given the expected migration of the baby boomers to the city, we know that if we sell into the resulting demand then we can reasonably expect to make a good profit on the sale.
But what are our prospects if we want to retain the property indefinitely for the income stream? Not too good I expect because the baby boomers who are heading for the big smoke are going to be seriously cashed up, having sold the family home, and looking to buy their own apartments rather than fork out rent to someone else. Thus, in this particular scenario it would be my opinion that trading the apartment for a profit will probably prove more prudent than holding it for the long term as an income producing asset…remember this is just my opinion.
So given the opposed objectives of traders and investors, you can appreciate the importance of knowing which category you belong to. My preferred approach to the Stockmarket is to trade shares whilst I consider real estate to be superior to shares as a lifetime income producing asset.
Shares are an intangible product which makes them ideal to trade in because they don’t require any infrastructure. I don’t have to physically take possession of the shares, they don’t require maintenance and there is always a ready market of buyers and sellers. On the other hand I’m not too fond of shares as lifetime income producing assets because there’s no guarantee that the companies which the shares represent will be around for my lifetime.
Property on the other hand isn’t about to be sold out from under me because some board of directors, that I have no influence over, think it’s a good idea. What’s more property is typically more stable in terms of its income revenue and the banks are far more user friendly when it comes to gearing a property portfolio than they are a share portfolio.
But buying and selling the family home was enough of a saga without making a business out of it by trading in investment properties…imagine the headaches. Hence, while there is the odd exception such as buying and selling inner city apartments, my preferences are to trade shares and invest in property.
This extract was re-produced with permission from Alan Hull. For more information on Invest My Way, or to purchase the book please click here
Mention the word “superannuation” and many people begin to yawn. Which is a shame, because a small degree of active interest in your superannuation fund now can potentially make tens of thousands of dollars difference to your retirement nest egg down the track.
Tens of thousands of dollars. And it’s crazy not to make the effort, because the money has to sit there anyway.
As an example, for a 25 year-old on an average income, a 1% reduction in fees on their super fund could potentially mean an extra $50,000 in today’s dollars at retirement. That’s a damn nice world tour, just for the effort of choosing a lower-cost super fund.
Or another example – that same 25 year-old on average income could potentially increase their nest egg by more than $140,000 in today’s dollars by choosing a fund that provides an extra 2% per annum return. Surely that extra return is worth just a little bit effort on your part, in choosing a fund that suits you?
The problem with superannuation (I have decided, based on my decade of experience as a financial planner, not to mention the hundreds of discussions I have had with readers of my blogs and columns) is twofold. Firstly: legislative change. Since superannuation became compulsory in 1992, the government has made over two thousand changes to the legislation. Changes to the amount you can put in, the amount you can take out, the degree to which it is taxed, not to mention the age at which you can access your superannuation. There has been no long-term consistency to the way that superannuation has been regulated and hence many people have no real confidence that they will be able to access the money, down the track, when they need it.
Secondly: financial literacy. While many Aussies are quite financially savvy, there is still a reasonable proportion who simply don’t understand how superannuation works. Which isn’t surprising, given the aforementioned legislative change! Personally I believe that, since our money is compulsorily taken from us and placed into a superannuation fund until we reach retirement age, there should also be a level of compulsory education provided by said superannuation funds.
Still, that’s a hobby horse for another day!
In the absence of compulsory education, there are some fantastic resources out there for workers to get a bit of a head start. The government’s MoneySmart website has some great general information on superannuation. They also run some excellent retirement planning calculators, to show you in dollar terms the reward of lower fees/higher returns. The Association of Superannuation Funds Australia (ASFA) also runs the Super guru website for consumers which has some useful information. And then, of course, there’s my latest book Money for Nothing!
The sad fact is that only 20% of investors take an active interest in where their superannuation is invested. Sad – because of the potential difference that that interest could make. And the only cost to you in taking that interest? Well, maybe an hour or two of your time, every year or so. Surely that’s not too large a price to pay?
I’d love to know your thoughts though. DO you take an interest in your superannuation? If not, what is holding you back?
If the only money-based resolution you make this year is to follow these tips from finance expert Justine Davies, you will already be hundreds of dollars better off!
- Do a written budget. Yes we all know that we need one – but few of us actually sit down and do it! Having a written budget is invaluable because it tells you how much money is coming in, how much is going out and, most importantly, where it is being spent.
- Have a good filing system for tax. It doesn’t matter whether you keep it in a shoebox, a folder or an old handbag, but keeping the paperwork for everything and anything that you might possibly be able to claim as a deduction on your tax return can save you significant dollars.
- Have a good filing system for your bills. We waste a lot of money in overdue fees when we forget to pay our bills on time. Having a central place to file them (in due-date order) can avoid “forgetfulness” and save you some serious cash.
- Keep an eye on your grocery bill. We spend, on average, 12% of our income on groceries, which is a huge amount. That’s just what we buy; we also waste around $5 billion worth of food each year! The easiest way to save on groceries is to have a weekly menu and a shopping list. It helps avoid both wastage and impulse buys.
- Review your car insurance. Sometimes you can make the biggest savings from those “set and forget” costs. A 2011 CHOICE report found that young drivers could save up to $980 per year on the cost of their car insurance by shopping around. And technology means that it’s easy to do! Jump online and try comparison sites such as CANSTAR.com.au to find a good-value policy.
- Review your health insurance. Ditto with health insurance; there are hundreds of dollars in savings to be made by shopping around. Try the government’s privatehealth website (privatehealth.gov.au) as a good place to get started.
- Work out how much your mortgage is costing you. A $350,000 mortgage on average rates can cost you over half a million in interest payments alone over the life of the loan. Ouch! But just a modest increase in payment or decrease in interest rate can mean tens of thousands of dollars in savings and with the government introducing new mortgage comparison fact sheets this January, it’s never been easier to shop around.
- Read your superannuation statement. Only 20% of workers take an interest in where their superannuation is invested. But for a 25-year old on average income, a 1% per annum difference in return could make $50,000 difference to their nest egg. That’s a fantastic round-the-world holiday!
- Pay off your credit cards. We owe around fifty billion dollars on credit cards at the moment, and three-quarters of that accrues interest, which is a nice little earner for the banks. It’s also a big drain on your monthly cash flow so work out how much you owe, divide it by 12 and try to start making regular payments to get rid of it! If you can’t get them paid off quickly then shop around for a lower interest rate card – that alone could save you hundreds of dollars each year.
- Get your partner on board. There is no point in you working your butt off to reduce your costs if your partner doesn’t help you. So put aside an hour to sit down together to work out a financial plan that you both agree to, going forward. (Note: a nice bottle of wine can help this process!)
Justine Davies is a financial planner, journalist, blogger and author who loves educating people about money. Her latest book, Money For Nothing (RRP $24.95), is published by Wrightbooks and is out this month.