Tuesday, March 27, 2007
From little things, big things grow
If you're just starting out with the sharemarket, you might be interested in this recent article from Brisbane's Courier Mail.
The idea of investing a little regularly over time is a good one - it teaches you good saving habits and let's you get started quickly without having to amass a fortune first.
Room for small investors
March 10, 2007 11:00pm
PRIME Minister John Howard last week announced we had reached the stage where more Australians owned shares than were members of a trade union.
At the same time, share markets everywhere tumbled in response to a drop in the Chinese market – billions were wiped off prices. This is all good news. We urgently need to get Australians being comfortable with investing in shares because no other investment has the potential for big gains, or the flexibility that shares offer.
But investors need to understand that markets can fall suddenly, as well as rise, and that hanging on, or even buying, when the inevitable bad patch hits is the only strategy to adopt.
A major benefit is that the income from shares that pay franked dividends is tax-free for anybody earning less than $75,000 a year, while the ability to deal in small parcels makes it easy to minimise capital gains tax.
This flexibility enables investors to start small and fine-tune their portfolios when appropriate. It is a simple matter to sell $5000 worth of shares, but you certainly can't sell the back bedroom of your rental house.
Many people start off borrowing for shares using margin lending. This is a strategy whereby you invest money in shares, or share trusts, using borrowed money with the shares themselves as the only security for the loan.
To protect its position, the lender will require you to maintain a margin between what you owe and the value of the shares. This is known as your loan-to-valuation ratio (LVR). The LVR varies between lenders and also on the type of shares bought.
For example, the LVR for blue-chip shares may be as high as 70 per cent; but for speculative shares, less than 50 per cent.
If the market falls, and the value of your portfolio falls to a level where you are below your LVR, you may receive a margin call. This is a request from the lender to provide additional security by way of cash or more shares.
If you cannot do this, the lender may force you to sell shares to reduce your debt back to within its agreed loan-to-valuation ratio.
The result may be that you are forced to dump quality shares at the worst possible time.
When possible, borrow for shares using a home equity loan. Then there can be no margin calls unless your property's value slumps.
This may not be possible for everybody because they may not own a property or, if they do, the equity in it may not be enough to justify extending the mortgage. For them, margin lending is fine, provided their income is secure and their budget can handle the repayments.
But it would be advisable to adopt a conservative loan-to-valuation ratio, and reinvest all dividends to add value to the portfolio faster.
If you are just getting going and do not have much money available, a good option is a regular gearing plan whereby you invest, say, $300 a month and match this by up to $600 of borrowed money making a total investment of $900 a month.
After 12 months, you would have invested $10,800 of which $7200 is borrowed.
This provides a gentle introduction to share investing, and by investing every month you practise the strategy of dollar cost averaging that enables you to maximise profits if the market is falling.
Another option for those who wish to start in a small way, is to borrow $5000 or $10,000 by way of personal loan or credit card. If the loan is paid off within 12 months, the interest is minimal and the fact that it is tax-deductible means that the Government will subsidise up to 46.5 per cent of it.
This gets around the high minimum loan levels of many margin loan providers.
Above all, investors who borrow for shares should appreciate that it is a long-term strategy and it is normal for the values of share-based investments to rise and fall.
Panicking and cashing out when the market is having one of its normal downturns could cause a needless loss of money.
Remember, $200,000 invested in shares in August 1987, was worth $121,260 two months later. Today the same portfolio would be worth $1.21 million if all dividends were re-invested. Those who bailed out when the crash hit were the big losers.
Noel Whittaker is joint managing director of Whittaker Macnaught Pty Ltd, Australian Financial Services licensee No. 246519