Encouraging young people to take that next step in anything is I guess an age-old challenge, and often it’s experience that is the teacher. Here are a few thoughts on the subject of making investments and avoiding losses.
Let’s start with the idea of diversification. While the common interpretation is not “putting all your eggs in the one basket”, in an investment portfolio true diversification involves selecting assets, the characteristics of which are not related to each other. Generally, for example, you would think that CSL (a pharmaceutical company) is very different to Transurban (an operator of toll roads). With the onset of COVID-19, CSL would probably benefit from the increased sales of pharmaceuticals, but Transurban would suffer as road users were locked down.
This might seem obvious if you have done your homework, but remember it’s not the obvious things that catch you out. Consider if CSL and Transurban, as different as they are, both carried high levels of debt. In that case, no matter how different the actual businesses are, an expectation of a rise in interest rates would hit them both. Lesson one – debt joins everything at the hip.
Reading the financial press (in particular, the Australian Financial Review) will give you a very good insight into what’s happening and topical. Even good journalists however can have a propensity to ascribe movements in stock prices to some particular issue, when in fact the movements are caused by something else altogether. CSL again provides a great and recurring example. Journalists have ascribed its recent lacklustre share performance to the botched rollout of the Astra-Zeneca vaccine (which CSL now makes in Australia). But CSL is underwritten by the Federal Government for the manufacture of that vaccine, so it’s not that. Having followed CSL since the day it listed, I can tell you that most of the company’s revenues are denominated in $US. With the $A strengthening against the $US, revenues reported in Australian dollars will be suppressed – nothing to do with the company per se, and everything to do with the exchange rate. It is also a fact that if, contrary to the AIDS focussed press reports in 1994, an original investment of $2.20 at the time of the float is now worth $875.25 (the float was so unpopular they reduced the price by 10 cents). Lesson 2 – read to remain informed, but actively apply your own learnings.
Market efficiency comprises the idea that the price of an investment will incorporate all the knowledge available regarding that investment at any point in time. A huge focus for financial types and academics, purists say there is no benefit in doing any investment-specific research because there is nothing more to learn. But what if investors are prone to jumping on bandwagons or we filter what is known to suit our narrative? And people are quite capable of moving in a herd-like fashion. Consider Santos which built one of the CSG plants on Curtis Island. Excited investors initially drove the price to $18.00 or so. Then cost overruns and funding problems led to an outpouring of negativity. The price drifted, and then over four years from 2014 plummeted to about $2.90. Headlines suggested that this almost 70-year old icon was going broke. If you had invested at $2.90, you would now be up more than 130 per cent. Lesson 3 – look for opportunities beyond the noise – the market always overshoots.
Finally, property. If the share market is all about numbers, residential property seems to be associated with amazing emotional attachment. Lots of claims are made that “property prices only ever rise”, that you can’t beat “bricks and mortar” security. And there is absolutely no doubt that many, many fortunes have been made in property – not only by investors but also by many people who just bought a house to live in. But not all property is the same. As any real estate expert will tell you, location matters. So does the difference between a unit and a house, and as with anything so does the time when you buy. Right now, many people are bleeding because they paid too much for recently built high-rise units in capital cities. Some that bought into booms locally found years later that the market dipped and recovered, leaving them square at best. You cannot control the market so with such large outlays you need to make sure your investment property stacks up as an investment. Negative gearing is a trap – tax deductions soften the blow, but losses are losses and need to be made up for through capital gain. Even if capital growth is likely, you cannot be sure when. You cannot cut off a bathroom to eat, so as best as you can, make sure you are not going to need to sell into a bad market. Look for a property with a ‘something extra’ that others might find appealing, or that you can add value to yourself without employing too many tradies. Do some cash flow modelling so you can plan how you will pay off borrowings, without leaving yourself too tight. Lesson 4 – Always position yourself for the long game.
Hope that all helps.
Please note this article provides general advice only and has not taken your personal, business or financial circumstances into consideration. If you would like more tailored advice, please contact us today.
