Investing in Shares
Date: February 29, 2016
The sharemarket gives individuals the opportunity to buy and sell shares and gives companies the opportunity to raise funds via share issues to investors. A quality sharemarket investment can lead to both capital growth and income over time. Historically, shares have outperformed all other asset classes (cash, fixed interest and property).
What is a share?
When you purchase a share, you’re effectively purchasing part-ownership in a company which is listed on a stock exchange (either in Australia or one of the many stock exchanges around the world). This part-ownership entitles you to a share in the company’s future profits which you receive in the form of share dividends. You also have the opportunity to benefit from the potential growth in share price as the company grows, which means your initial investment is growing as well.
Generally, a company will list on the stock exchange to raise money for planned activities, such as further expansion of their markets, an upgrade in technology or even the purchase of another company which complements their core business.
What types of shares are available?
You can purchase shares in a range of Australian and international companies. Company shares are available across many industries, from manufacturing and heavy industry to retail and exporting. In addition, you also have access to a range of property investments listed on the stock exchange, including office buildings, shopping centres, car parks and tourist resorts.
What are the benefits of share investing
There are a number of key benefits, including:
The ability to diversify risk
Share market investments involve an element of risk so diversifying your share portfolio is important. This means ‘not putting all your eggs in the one basket.’ In other words, spreading your investment risk across a variety of asset classes (eg retail, manufacturing and industrial companies), as well as a range of companies. Investment performance is cyclical and although there will always be peaks and troughs, a diversified investment portfolio allows you to balance out short-term troughs with cyclical peaks in performance ultimately smoothing your investment performance over time.
Shares out-perform over the long term
Shares are a long-term investment (five to seven years) and this helps smooth out the short-term risk and fluctuations in investment performance.
Income stream and capital growth
Over time, the share price increases, so does the value of your initial investment. This is called capital growth and is important in helping your investment increase in value over time. In addition, regular income payments or dividends are paid by listed companies from profits. This gives you an ongoing income stream. Not only that, but as a company’s share price is increasing, so are the dividends, because the dividends payable are calculated as a percentage of the value of the company.
Share Dividends *
Have you ever wondered why so many investors are enamoured with dividends? I mean, it’s not so different to bank interest – what’s the big deal, right? Well dividends, especially Australian dividends, are like bank interest but turbocharged. And that’s a beautiful thing.
When you receive your bank interest you’re getting a known return on your money. It’s known in advance, regular and dependable, and they’re all undoubted positives. And frankly, interest from a large bank is more certain than dividends. But dividends have a few key advantages:
They tend to be better than bank interest and rent
Bank accounts are safe. Property is physical “bricks and mortar”. But both are likely to give you low (or very low) income returns. Bank interest might be about 0.1 per cent or 0.5 per cent at call, and you might get 2 per cent or 2.5 per cent if you lock your money up for a year. If you’re investing in capital city property, you might get something similar – or less – in rental yield, but don’t forget to take out the property manager’s cut. The average ASX 200 dividend yield is likely to be more than 4 per cent – and higher if you choose well.
They have unique tax advantages
Bank interest is taxed at your marginal tax rate. If you’re in the 32.5 per cent tax bracket, you’ll lose a third of your interest in tax. Ditto your rental returns. But if you buy shares in a company that pays “fully franked” dividends, you get to deduct the tax already paid by the company when calculating your own tax payable – meaning you’ll pay mere cents in the dollar in tax. So your 2 per cent bank interest is closer to 1.3 per cent after tax. Your rental yield of (generously) 2.5 per cent leaves you with maybe 1.7 per cent, but a 4.5 per cent fully franked dividend leaves at least 4 per cent in your pocket.
What is dividend imputation?
Most companies listed on the Australian Securities Exchange pay tax on their profits before dividends are distributed to investors. In other words those dividends come to you ‘tax paid’.
Your personal tax liability will be calculated after taking into account the tax that has already been paid by the company. The aim is to ensure that those profits are only taxed once. As a result, investors on low tax rates either pay no tax on the dividends or even qualify for a tax refund, while investors on the top marginal rate of 49* per cent pay little tax on ‘fully franked’ dividends.
* Including 2% Medicare levy and 2% Temporary Budget Repair levy
Things to consider
The risks of investing in shares
There are two main risks associated with shares but fortunately both of these can be managed:
- The price of any particular share can fall unexpectedly and dramatically without much or any notice, however, the practice of diversification can lessen this risk. So if one does fail, the value of your overall portfolio should only be affected slightly. For more information please refer to the relevant fact sheet titled Investment Risk and Return
- The share market can experience fluctuating returns. While this can be stressful history tells us, the share market will generally improve its value over the medium to long term.
Why do share prices fluctuate?
It can be difficult to tell why in the short term share prices can fluctuate. Although, over the long term, the share prices of businesses listed on the stock exchange usually increase because of cautious financial management by the directors of the company. An investor should be aware that not all company profits are distributed to investors as dividends.
Part of the revenue will generally be kept by the company to reinvest into the business (for example to develop better technology, to buy other business, or to expand into new markets).
Through these activities, it is hoped that over time the value of the company grows, and this will have a positive effect on the share price and dividends.
Similarly, if a company is performing poorly or is subject to bad financial management or loses key staff, the residual panic in the markets can lead to the sale of company shares, resulting in a decrease in the share price.
Source: Lonsdale (Jan 2016) and * SMH / The Motley Fool (25 Feb 2016) http://www.smh.com.au/money/investing/motley-fool-the-beauty-of-dividends-20160225-gn3s5z.html#ixzz41WLx6UKB