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.

Numeric Example

• 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