Beginners Article 3: What Are Your Options?
What are your options?
After last week’s article, we now know what you get when you buy a share. But the question remains – how should we be investing our hard-earned? Before getting into the nitty-gritty of investing styles, risk profiles and portfolio construction, we need to have a look at some of our options. Should we be doing all the work ourselves? Or is it better to let someone else take the wheel? Here are a few options to think about…
Listed Investment Companies (LICs)
A LIC is an investment vehicle listed on the ASX that offers investors access to a diversified share portfolio with just one purchase. LICs are similar to managed funds as they have a fund manager who makes the investment decisions. However, in purchasing a LIC you are buying a part of the company, not a share of the investments, and as such the value of your investment change can change with both a change in the value of the company’s holding or a change in the confidence in the fund managers ability to perform.
LICs are mostly closed-end funds. Whereas a managed fund manager will have to invest your money when you put it into his fund, with a LIC you are simply trading in shares of a vehicle that holds a lump of already invested money. They also often have a lot more transparency over what the funds are invested in and the mechanism the fund managers use. LICs have to market themselves a bit harder than other investment options, so they tend to tell you what they do.
Exchange Traded Funds (ETFs)
Australian investors who want a diversified portfolio in a particular asset class without having to manage it themselves are able to buy ETFs on the ASX. As the name suggests, ETFs are exchange-traded on the stock market, meaning you can buy and sell them in the exact same manner as shares. They can be purchased through a broker or an online trading account, and the main benefit is that they allow you to buy exposure to markets and asset classes that were previously inaccessible (unless you opened broking accounts with international equity and futures brokers).
While the LIC market is mostly a small domestic Australian affair, the ETF sector is much larger market globally and is the plaything of the much bigger international investing community.
The main attraction of ETFs is they don’t have the same volatility as shares, they simply give you the return of the market, sector or asset class of your choosing. It’s a lot easier (and less stressful) making a few decisions each year about which country and currency to be in than it is managing the volatility, decision making and paperwork on twenty separate equities. In the ETF world your investment concerns boil down to timing asset allocation rather than managing events in individual shares which is more risky, volatile and tough to manage.
Unlike our previous two options, managed funds are NOT exchange-traded. This means that there are some barriers involved in buying and selling most unlisted managed funds, something that might matter if the market moves sharply down and you want to pull your money out. Managed funds typically have minimum deposits, slightly higher fees and a little more paperwork than LICs and ETFs.
When you put your money into a managed fund your money is pooled with other investors to buy shares or other assets on your behalf. An ‘expert’ fund manager will then be in charge of the investments and will take care of the stock selection and diversification for you, hopefully just leaving you with the returns.
A managed fund is similar to a LIC, except that the value of your investment is based purely on the value of the assets held in the fund. Meaning you can’t lose money just because sentiment changes toward the fund manager or company.
Managed funds can be ‘passive’ or ‘active’. A passive fund will typically replicate an index or a group of securities. They are ‘boring’ and will return almost identical results to that of chosen index.
Active funds tend to operate with objectives, trying to beat a benchmark such as the ‘ASX 200’ or the ‘All Ordinaries’ rather than replicating a sector or an index, with the fund manager making decisions based on the investment goals of the specific fund. For example, at Marcus Today we have two funds called “Separately Managed Accounts” (SMA’s), with one targeting “growth” and one targeting “income”. A SMA is a type of managed fund, but instead of just having your money invested in the fund, the individual underlying stocks are held beneficially in your name, meaning you are the actual owner of each stock in your portfolio.
A LIC, an ETF or a managed fund might be an option for you if you are sitting there holding twenty plus stocks in a large diversified portfolio that, despite your efforts to add value, is now simply getting the average return anyway. It is a lot easier and less stressful to simply buy a market exposure through an investment vehicle that still pays you dividends than manage twenty or more stocks, making twenty stock decisions, doing twenty lots of paperwork and going grey in the process.
Traded like shares. Related to shares. But not normal shares.
Put simply, Hybrids are like term deposits but issued by companies in the share market rather than the bond market.
They’re like term deposits because most of them pay you an interest rate for lending the company your money and you will be offered your money back after a period of time (redemption).
When it comes to paying you interest, each year is divided up into either two or four periods and they will pay you out two or four times a year. You have to read the PDS (product disclosure statement) of each individual instrument to know its terms, how much it pays, when you get your money back and how much you get (sometimes you get shares not cash). And like a term deposit, there may be a sting if you want your money out early.
But it’s their names which give away the rest of the story. “Reset Preference Shares”, “Converting Preference Shares”, “Perpetual Exchangeable Resaleable Listed Securities”; sounds like shares and that’s because they actually are, because in the event the company that issues them goes bust, there is a pecking order of who gets paid, and holders of most hybrids will rank ahead of ordinary shareholders.
If a company goes bust the creditors get first crack at the assets. Hybrid holders get the next bite. Ordinary shareholders are last cab off the rank. After all, most hybrids are designed as “preference” shares – the holders have preference over ordinary shareholders – and so they rank above ordinary shares.
Hybrids are popular with investors focused on income, as most offer higher yields than bank accounts and bonds in return for you taking on some equity exposure. They are not risk-free though. Typically, they are about half as volatile as the underlying equity. A little more complex than some other options, but certainly something to think about if you’re after income and know what you’re doing.
Banknotes stuffed under your mattress will keep your capital safe, but it’s certainly not adding any value to it.
An interest-bearing cash management account will give you a small return and allow you to keep the flexibility of accessing it on short notice should you want to put it to use, but depending on rates the return will likely be minimal.
Term Deposits pay higher returns than cash management accounts but lock away your money for a set period of time (with hefty fees to take it out early).
They’re all ‘safe’ options (well maybe hiding cash under your mattress isn’t that safe), but probably not what you’re interested if you’re reading this.
Depending on your stage in life, investing money and time in yourself, your education or your business may be the option that sees the greatest returns over time.
We know what we’re getting ourselves into when buying a stock, but if you want to start investing there’s a little more to it than that.
After opening an online trading account or contacting a broker, there are a number of questions you need to ask yourself as an investor.
What kind of investor am I going to be? What are my goals? How much am I going to invest? What level of risk am I happy with? The list goes on…
Buying stocks, building a portfolio and developing your own investing style is the most mentally challenging and time-consuming option, but if you’re willing to put in the work it is certainly the most rewarding.