Get your portfolio receipe right

Published in the ASX Newsletter, February 2014 by Janine Cox

The key ingredients every beginner needs for success. Have you ever tried to make a pie without a recipe or plan?

How often does the amazing dish you thought you would create come out a flop or worse than your expectations because you missed a few important steps?

When it comes to the sharemarket, profitable investing ought to be as simple as following a recipe. 

In reality, many people who invest do not have a recipe or plan and as a result their investment pie does not end up as expected.

Successful investing requires the right preparation and having the right ingredients. Without them, you create a mess.

Many people I help with their sharemarket investments have previously made a mess or at least did not get what they set out to achieve because they stepped into the market without a recipe. 

The good news is that successful investing can be as simple as following a basic recipe time and again.

Below are four key ingredients to get you started:

1. Document your goals and why you want to invest

Unfortunately, most investors jump right in and buy a few shares without much thought or effort. 

There is an old saying that "if you fail to plan, you plan to fail", which rings loud and true when it comes to the sharemarket. 

Writing your goals has been proven to increase the likelihood of getting what you want.

Knowing your "why" is critical to achieve your investment goals.

As you write your goals consider these questions, and understand that the answers will help you pick the right shares. 

Are you after income, capital gains or both? Do you want to invest for the short, medium or long term.

2. Sharemarket truths

Have you heard that being forearmed is being forewarned? 

Here are seven important sharemarket truths.

  • Money or wealth is exchanged or transferred from those without knowledge to those with it. Remember the sharemarket is one big auction where you can buy and sell your very own stake in a public company, and you should never attend an auction without doing your research first.
  • The sharemarket runs on greed and fear. In this information age it is too easy for those with knowledge to release information so as to drive these emotions, so carefully filter what you read. A big tip is that more information is not better. It is more beneficial to limit your information sources and pay for quality independent research, rather than rely on free sources.
  • A broker is employed to make transactions and in return is remunerated through commissions, therefore it is important that you understand this relationship and that ultimately you are responsible for the outcomes of any transactions you choose to make. Regardless of how good or experienced your broker is, ultimately, if you are responsible, I suggest you know what you are doing yourself rather than relying on someone else.
  • Beginners mistakenly think if they invest in a 50-cent share that it is cheap compared with one that costs $50, which is seen as expensive. Basically, they believe they get more shares and as such are more likely to get a better return, which is untrue.
  • Managing risk is the most important aspect of investing. Preserving your capital and your profits from downturns in the market is critical to long-term success. I strongly recommend you learn to set stop-losses (a pre-determined point at which you sell shares, to cut losses or protect profits).
  • A great book to help you with that and in constructing your portfolio is 'How to beat the managed funds by 20%', by Wealth Within founder, Dale Gillham.
  • A big myth is that investing offshore leads to better returns or better diversification. Both are untrue. There are more than enough great shares in Australia to profit from.
  • Learn to sell. Most investors say they find it much easier to buy than to sell. In the sharemarket you need to do both, and knowing how to sell is by far the more important skill to have.

3. Getting the knowledge and the tools you need

Einstein said that "Education is the progressive realisation of our ignorance". 

I have found that once I have taught a person to understand how to invest properly, they tell me they understand where they were going wrong, how ignorant and high risk they were.

Getting the right knowledge can be difficult for new investors, given the mass of information out there.

However, for investors, choosing the right educator does not need to be hard as you can get a great free education on the ASX website. 

The ASX has education for beginners including the ASX Sharemarket Game that allows you to experience the market without having to put capital at risk. 

 If you simply want to buy a few shares and hold them, the level of knowledge you require will be much lower.

If you want to be a more active investor or perhaps a trader who wants to generate additional income, you will need to invest in some education such as the Diploma of Share Trading and Investment

A simple rule is that the more active or the higher the risk you take, the more education you need.

4. Getting your portfolio started

Beginners have two main options in my opinion.

Firstly, select eight to 12 stocks from the top 20 shares on the Australian market paying good dividends. 

Divide your money between them and leave the stocks in the bottom drawer, as history has proven they will grow over time. 

Also, remember smaller portfolios are easier to manage and represent lower risk.

The more stocks you have, the more work is needed to manage your risk and the higher your transaction costs.

To illustrate the benefits of sticking to the bigger shares, below is a bar graph of the Australian sharemarket indices in 2011. 

Each colour represents a different index. The top 20 (blue) and top 50 (red) contain the biggest most-liquid stocks on our market. 

The other indices contain the stocks in the top 50 plus stocks outside of this index. 

On the left of the graph is the percentage decline experienced by each index in 2011.

What this demonstrates is that the bigger stocks were less volatile and generally lower risk in the downturn than stocks outside this group. 

One year does not give a conclusive picture but it does provide hints as to what might normally happen. 

Would it surprise you to know that the top 20 and top 50 indices outperformed the other indices shown in 2012 and 2013? 

This is why we say that investors should concentrate on the biggest and best shares.

Chart 1: How different groups of ASX-listed stocks (by size) performed during 2011

And secondly, get an education and learn how to be more active in your investing so you achieve higher returns or learn how to generate an income stream from the market. 

 This article is just the start of your own investing recipe. 

To really be successful in the long term I urge you to continue to build your knowledge so you can create your wealth and safely invest in the Australian sharemarket.

To learn how you can gain the required knowledge and skill to ensure your success in the sharemarket click here.

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