Factors to consider when investing in direct shares

12 November 2019 | Investment principles

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Australia has one of the highest rates of share ownership in the world. According to an ASX Australian Investor Study, approximately 37 per cent of Australian adults hold shares either directly (31 per cent) or indirectly (7 per cent derivatives and 11 per cent invest in other on-exchange investments), making us a country with one of the highest rates of share ownership in the world.

Some investors find buying individual shares enjoyable and rewarding. Others may find it deadly dull, time-consuming and too risky. While there is no definitive answer as to whether you should invest in direct shares or not, your decision should be based on personal interest, financial wherewithal and your individual investment goals.

If you are thinking about taking the leap to invest in direct shares, here are some factors to consider:

Diversification is key

The ASX found that a majority of investors don’t know if their investments are diversified, or that they do not have diversified portfolios (55 per cent). This is further proven by the finding that 75 percent of share owners only hold Australian shares.

Instead of putting all your eggs in one basket (or market) and buying shares in a single company or sector, there are a number of advantages to diversifying your investment across a variety of companies. In doing so, you can reduce your risk - when some shares struggle, others are likely to deliver stronger returns that limit your downside, giving you the confidence to remain invested even during periods of market turmoil.

But diversification involves much more than buying a collection of shares. The average Australian share portfolio is invested across five companies. If just one of those companies was consistently performing badly, that would mean that at least 20 per cent of the share portfolio is delivering negative or poor returns.

To be properly diversified, you will probably need shares that represent different company sizes, industries and locations. You will likely need to assemble shares across a group of companies that are not likely to move in the same direction at the same time. That might mean purchasing shares in dozens, or hundreds, of companies. In other words, you will not only need the resources to invest but you will also need to pay the fees on each trade.

In contrast, an exchange-traded fund (ETF) provides a low-cost diversified portfolio for as little as $500, making it a more accessible choice for many investors.

You could do a little of both, or more accurately a lot of one and a little of the other, to help with diversifying your investment portfolio. With this approach, you would invest the bulk of your funds in a managed fund or ETF to easily achieve diversification and purchase a few direct shares in small amounts on the side. This allows you to scratch that “I know this is the next big thing” itch without risking your life savings. Some financial advisers for example set up portfolios with a % allocation for the investor to use to take their direct bets.

Recognise that it’s hard to beat the market

Despite having the experience, time, and resources, the vast majority of professional investors often fail to beat market indexes. As such, a realistic perspective of your expected returns can help you manage your expectations. You should also be prepared to dedicate time to research companies so that you understand what you are investing in. Even so, history has often shown that investment success is more often delivered by time in the market, rather than by timing the market.

Understanding stock risk

You may believe you can forecast the next winning industry – technology stocks for instance. But will you be able to pick the right stock? What if, in the early 2000s, you’d bought the next WorldCom instead of buying Apple and Google? Arguably the single biggest challenge facing direct share investors selecting high-fliers before gains are built into the price.

Keep your eye on taxes

When you buy and sell shares, you may generate taxable gains. Frequent trading is likely to increase these taxes. Keep an eye on how your decisions to buy and sell may impact your tax bill.

No matter what you decide, start by identifying your goals and then create a low-cost, diversified portfolio to achieve them. (This article has focused on shares, but bonds should also play a role in most portfolios.) Then, fill that portfolio with direct shares, funds, or some combination of the two based on your interests, financial capacity and willingness to take on additional risk.

 

Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.
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Robin Bowerman, Head of Corporate Affairs at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.

Robin Bowerman