Investing in the share market is a relatively easy, simple and a low-cost investment strategy to implement, if you know the right way to do it, of course. However, if you don’t know what you’re doing, it’s easy to mess it up. In this blog, I set out how to implement a highly successful (over the long run) share market investment strategy using a low-cost, evidence-based approach.
Of course, the information in this blog (and in fact, in all my blogs) is general in nature. It’s not written or tailored for you, as I do not know your personal circumstances, goals, risk appetite and so on. Therefore, be careful. If you have any doubt, always seek independent financial advice.
There are three steps to implementing a share market investment strategy.
Step one: chose your investment methodology
When investing in the share market, you have three broad options:
- Invest in direct shares i.e. pick the stocks that you would like to buy;
- Employ the services of professionals to pick the stocks on your behalf e.g. use a stockbroker or actively managed fund; and/or
- Invest in low-cost index funds (this could be described as a rules-based approach to picking which stocks to invest in).
Regular readers of this blog will know that I strongly believe in only employing evidence-based investment approaches. And there’s an overwhelming amount of evidence that demonstrates that index investing has the greatest probability of generating the highest returns over the long run. If you’d like to learn more, I present this evidence in this blog and also in my book, Investopoly.
Some people are attracted to investing in shares for fun (i.e. a bit of excitement). A perfect example of this is what happened to US stock, GameStop and other meme stocks. The core purpose of investing is to build wealth, not to have fun! In fact, if done correctly investing should be boring. Although the process might be boring, the outcome is exciting!
Step two: pick the product
Now that you have decided to adopt an indexing methodology (if not, return to step # 1!), it is time to pick the product you will use.
I strongly recommend you use a diversified product. A diversified product invests in a variety of sub-asset classes such as Australian shares, international shares, emerging markets, bonds and smaller companies. The asset allocation is professionally managed which means there’s less room for error. Currently, two Australian ETF providers offer these products:
- Vanguard – VDGR has a very broad asset allocation with 70% invested in shares and 30% in bonds. VDHG has a more aggressive asset allocation with 90% invested in shares.
- BetaShares – DHHF is 100% invested in shares i.e. no bonds.
- Ethical investments – BetaShares also has some ethical options including DGGF (70% in shares) and DZZF (90% in shares). These funds screen out companies that are large carbon dioxide emitters i.e. fossil fuels.
Whilst bond returns are currently low, bonds still play a very important role in a portfolio because they have a negative correlation with shares. How important this is to you depends on your situation and risk profile.
BetaShares products are relatively new (established in Dec 2020). However, the Vanguard funds have a much longer track record (established in 2002), albeit in managed fund form (and only recently offered in an ETF form). You can view long term returns here and here. Both have returned over 10% p.a. over the past 10 years.
In terms of how to invest in these ETFs, you can do that using an online share trading account. If you invest in Vanguard’s ETFs, you can use its new Personal Investor service which allows you to buy one of its listed ETFs for only $9 per trade. If you want to invest in a BetaShares ETF, you need a retail share trading account such as CommSec.
Step three: implementation
Because the share market can be highly volatile, the best way to invest is incrementally in small tranches over a long period of time e.g. monthly or quarterly. This helps spread your timing risk. Timing risk is the risk that you lose money because you picked the wrong time to invest a lot of money in the share market i.e. just prior to a crash. This chart is a good reminder of how volatile the share market can be. Therefore, you need to decide how much you are comfortable investing each month or quarter. One of the advantages of a share strategy is that you can increase or decrease this amount if your circumstances change. It is very flexible.
Some additional considerations include:
You will need to think how to own these investments. Typically, your options include sole name (you or your spouse, if you have one), joint names (if you have a spouse) or a family trust (click here for a presentation about family trusts). It may be worth speaking to your holistic accountant about this.
Depending on your goals, circumstances and risk profile, you may consider boosting your regular investment amount with some borrowings. For example, if you had $3,000 per month of surplus cash flow, you could set up an investment loan (mortgage) secured by your home and draw $3,000 per month from that loan. This would allow you to invest $6,000 per month funded 50% from cash and 50% from borrowings.
What results can you expect?
The chart below sets out the results an investor could have achieved if they started investing $3,000 per month 20 years ago. The investor’s investment portfolio would be worth $1,828,000 today consisting of $720,000 of capital contributions plus $1.1 million of growth. And if they continue investing, the investor’s portfolio could be worth $4.6 million by 2031 i.e. in 10 years from now (consisting of $780,000 of capital plus $3.8m of growth). Pretty extraordinary, right?
The thing I like the most about this chart is that is demonstrates that sometimes you can do everything right for many years but not enjoy any results. For example, if you started investing in 2001, by 2008 you would have earned zero return (thanks to the GFC). This can happen despite employing a sound, evidence-based approach. But investor’s that have the discipline and fortitude to stick with it, play the long game, have faith in evidence-based strategies, are always well-rewarded in the long run.
Financially model your own scenario
Click here to download my regular share investing financial model (Excel spreadsheet). It allows you to alter the monthly investment amount to model various scenarios.
When do you need independent financial advice?
As described above, this is a simple strategy to implement. However, the more you invest, the greater the scope there is for a financial advisor to add value. They might be able to deliver value in several ways:
- The diversified options mentioned above tend to distribute too much income. For example, the Vanguard Growth fund generated a return of 9.30% in the 5 years ended July 2021. This consisted of 7.07% p.a. of income plus 2.22% of growth (the High Growth fund generated 7.63% income plus 3.48% growth). Obviously, income is taxed each year. But growth isn’t taxed until you sell the investment. For many investors, it’s more tax effective to have more growth and less income. The tax implications become more material with the more money you have invested. Also, there may be other ways to structure a portfolio to minimise tax.
- All diversified investments use traditional market cap indexing only. I have written about the limitations with this methodology in the past – click here. The more money you have invested, the more important it becomes to use a variety of rules-based indexing methodologies, particularly in this market. By way of an update, last financial year (2020/21), fundamental indexing outperformed by 4.5% and Dimensional by 4%. Of course, longer-term returns mentioned in this blog are more reliable.
- An advisor can construct an investment portfolio that is tailored to your specific needs and risk profile. For some investors, capital preservation is more important than investment returns, so investing in safer assets other than bonds becomes important. Other investors are willing to take higher risk and skew their portfolio towards the sub-asset classes and geographical markets that are positioned to provide the best returns over the medium to long term.
Whilst it is difficult to formulate a perfect rule of thumb, my view is that if you are investing more than say $3,000 to $5,000 per month, and/or your existing portfolio exceeds circa $400,000 in value, then it is likely that you would benefit from engaging an independent financial advisor to manage your portfolio on an ongoing basis. Notwithstanding that, there might be other things they can help you with.
Keep it simple and do it regularly
As the chart above demonstrates, monthly investing over long periods of time generates substantial wealth. The strategy is flexible and lower risk than borrowing to invest. And there has never been a time when this strategy has been easier and more cost-effective to implement. It is certainly worthy of consideration.