Putting all your eggs in one basket is a risky game
In the US, 35% of Americans own shares. One in three Brits hold direct shares, a figure that applies in Canada also. Perhaps the relatively low take-up of shares in Australia reflects our preference for savings accounts as a go-to investment.
Almost one in two households hold money in a savings account, but in today’s low-rate world many people could do their wealth a favour by looking beyond cash.
While savings accounts are very low risk, they are not without downsides. You’ll earn zero capital growth, meaning inflation will eat away at the purchasing power of your money over time.
Think of it this way. Reserve Bank data shows that on a 12-month term deposit, the average return is currently 0.3%. Hardly an impressive gain. To make matters worse, inflation is 0.9%. So, the spending power of your money is actually going backwards by 0.6% over the course of the year. That’s a terrible result!
This is why I’m a fan of shares and exchange traded funds. Yes, they involve more risk, but the payoff is the potential for higher returns over time. The catch is that with over 2,000 securities listed on the Australian Stock Exchange, choosing the ‘right’ shares can seem overwhelming. That’s where exchange traded funds (ETFs) come in.
Investing in ETFs is like buying into a basket of different shares. Your money is spread across companies, sectors and industries, without the need to pick individual stocks.
That matters because it’s often tempting to select individual shares on the basis of recent returns. This assumes the shares will continue to perform well in the future, which is not always the case.
Finder tracked the top performing shares of 2015/16 to see how they have fared over the past five years. Investors who’d tipped money into Northern Star Resources in January 2016, would have done well. Since then, the shares have notched up gains of 376%.
However, shares in Blackmores – another high performer of 2015/16, have dropped by around 70% in the intervening five years. This shows how tricky it can be to predict individual “winners” ahead of time.
By contrast, Finder found the top performing ETFs over the past five years have delivered returns ranging from 35% to 16%.
The beauty of investing is that the choice between direct shares and ETFs is not mutually exclusive. It makes sense to mix and match between the two. One strategy that can work well is to have a share-based ETF at the centre of your portfolio, and then build individual ‘satellite’ shareholdings around this. It’s a way to invest based on your views and preferences while still reaping the rewards of diversification.
For more on ETF investing or how to invest in a conservative portfolio click here: https://www.investsmart.com.au/conservative-portfolio