This article appears in today’s AFR.
When a stock market plunges 37% in a matter of a few weeks, it’s hardly surprising a lot of investors will smell a bargain and look to take advantage of the big drop in prices by snapping up some heavily sold shares. And given the market’s bounced 19% from its recent lows, so far it’s worked out well for a lot of them, but before you’re tempted to try your hand at doing the same thing, there are some important questions you should ask yourself.
Are you looking for a short-term punt or a long-term investment?
You might fancy your chances of making a quick trading profit, with the intention of being in and out within days or weeks, or even telling yourself you’ll hang on for a year or two. Seriously, anything that’s less than 3-5 years is a punt, not an investment, especially when there’s not a person on the planet that can tell you when the full effects of the most comprehensive economic shutdown we’ve ever experienced will have washed through. Like any punt, you’ll need to be prepared to lose money.
On the other hand, if you see this as an opportunity to start, or add to, a long-term portfolio, in other words, investing, there are still some questions to ask.
Personal or super?
First, do you think you’ll need to use the money for anything before you retire? If you reckon you’ll need to access it for other things, then it makes sense to invest in your own name. However, if you feel sure you won’t need to access the money once it’s invested, then you really should be looking at investing in your superfund if you can because it provides potentially enormous tax advantages. If your marginal tax rate is, say, 30%, compared to the 15% rate in super, that difference can really add up over several years.
That means you need to be on top of your super contributions: have you, or will you, max out your concessional contributions (for example, the ones you get through work) before the end of the financial year? If not, then topping up your concessional contributions to the $25,000 limit could bring you the added bonus of a tax deduction. If you have, or will, hit that limit then you can always explore whether you’re able to make a non-concessional contribution of up to $100,000. In fact, you’re able to bring forward three years’ of non-concessional contributions in one hit.
You need to be careful of the details here, so if you’re unsure, you really should speak to a financial adviser, and while there’s a bit more hassle involved, rest assured, the difference in tax will be worth it.
DIY or outsource?
When share prices have fallen a lot, it’s easy to think you can’t lose no matter what stocks you pick. That couldn’t be further from the truth. Again, we don’t know how long or deep this downturn will be, and while the government is stepping in to plug some of the gaps, that money should be seen for what it is: a rescue package, not a stimulus. There’s a very real risk businesses could fail. In just the past few weeks dozens of Australian companies have had to raise money through share placements to prop up their balance sheet.
If you don’t feel confident you have the skills or knowledge to be able to work out whether a company has what it takes to survive, then you’re taking on a lot of extra risk. Alternatively, if you decide you haven’t got the skills or knowledge, you can outsource the decisions to a fund manager, whose analysts are trained to pick apart a company’s financial accounts and who are often able to pick up the phone to a CEO or CFO at short notice.
Specific stocks or index?
There are literally hundreds of different fund managers out there, but once you go down that path you face just as big a challenge working out which ones are any good, or which style best suits you: value or growth, big companies or small, fundamental or quant?
If choosing a fund manager, or selecting which stocks are going to survive and prosper is simply too daunting, you can opt to buy an ‘index fund’. These funds simply replicate either an entire county’s share market, or a part of a share market, or even a region’s share markets, like Europe or Asia. You can buy what’s called an Exchange Traded Fund (or ETF), which will replicate an index, as easily as you can buy individual shares on the stock exchange. Popular ETF issuers in Australia include the likes of Vanguard, iShares, BetaShares or SPDR.
The advantage of buying an index fund is you get instant diversification and it takes the decision making out of your hands, which is why it’s also called ‘passive’ investing, as opposed to trying to pick stocks, which is called ‘active’ investing. Importantly, you can reduce your risk even further by buying index funds for a variety of different markets, a process called asset allocation.
This stock market correction could turn out to be the opportunity of a lifetime or a nasty bear trap, and the difference can boil down to knowing what you don’t know.