Negatively Gearing the Stock Market

This is a guest contribution from Jeremy Kwong-Law

We have a national obsession with property investment in Australia. A key reason is because of the tax benefits of negative gearing. The idea of paying less tax is simply too appealing to most people (who can afford it).

Negative gearing only makes sense if the capital gains on the asset is more than the interest cost. Otherwise paying less tax is really because you are making less money, and losing wealth along the way.

Most people only think of investment property when they think about negative gearing. But there are actually other asset classes where negative gearing can be effective. The stock market is one of those.

Individual stocks are too risky to apply a long term negative gearing strategy. However, index based Exchange Traded Funds (ETFs) could be a suitable option. I previously wrote about why ETFs are a better way to achieve a diversified portfolio compared to direct stock holding (here).

With this concept in mind, I tested a $500K investment in the SPDR ASX 200 ETF (STW) using a negative gearing strategy. A $500K negatively geared investment property in Sydney was the comparison case. I selected the SPDR ETF because it is the oldest index ETF listed on the ASX, providing the most data points.

Over an investment time-frame from 1 Jan 2005 to 31 Dec 2014, the investment property offered better outcomes through negative gearing:

• Return on Equity on the property was 206% compared 104% from the ETF
• Total tax offset for the property was $214K compared to $116K from the ETF

 Despite this, the analysis shows that negatively gearing the Aussie stock market is a viable option. In fact, ETF offered a few benefits compared to property investment:

• Lower entry cost - A deposit for an investment property is likely to cost more than $100K, whilst you can start an ETF portfolio with a few $1,000s
• ETFs are much more liquid than property
• there is a lot less hassle compared to property investment. ie. no need to manage tenants / real estate agents
• lower transaction costs - buying an ETF is as cheap and simple as buying a stock with your online broker. Buying an investment property is difficult and expensive. You need to consider legal fees, stamp duty, and other costs

Funding

To fund the two investments, I assumed a loan at 65% LVR or $325K. This leaves a $175K equity / cash investment at the start. The mortgage's variable rate is based on the RBA’s published rate across the 10 year period. The Margin Loan for the ETF is assumed to be 2.85% p.a. more expensive than the mortgage. This difference is the spread between a CommSec Margin Loan and a CBA mortgage as at May 2015.

Both loans are repaid on a monthly basis, to the same dollar value. At the end of the 10 years, principal outstanding is $256K (79% of the initial loan amount).

Running costs & other tax offsets

The cost of the ETF is completely absorbed within the unit price so there are no other fees to pay - ever. For the investment property, there are a few costs:

• Real estate agent management fee of 6% of rental income;
• Depreciation on the property - I assumed 40% of initial investment is depreciated (some consultants suggest you can depreciate up to 60%!).

Income

The ETF pays a semi-annual dividend. Over the 10 years, it provided an average annual yield of 4.7%. I did not factor in franking credits.

The property starts off at 3.5% gross rental yield. Rent rise every year in December, at the rate of Sydney rental growth (ABS data). Over the period, average annual yield is 3.8%.

Asset Value

Property value in Sydney achieved big growth in the past decade, gaining 58%. The $500K property in Jan 2004 was worth $792K in Dec 2014. The Aussie stock market didn’t do as well over this period. The ETF share price increased from $40.79 to $50.25, a rise of 23%.

The higher asset value growth of property also translates to much higher equity value growth. Equity in the property grew from $175K to $536K, an impressive 206%. The ETF equity value grew from $175K to $357K, a 104% increase.

Tax offset vs cash flow

Obviously this whole strategy is about tax offsets - both investments achieved this. The property had tax offsets of $213K over the 10 years, whilst the ETF offered $117K of tax offsets.

Interestingly, the property offsets were achieved with lower impact on cash flow. Negative cash flow for the property investment was only $82K over the 10 years. The ETF had $117K of negative cash flow. This is mainly because property is able to claim non-cash tax deduction in the form of depreciation.

What does it all mean?

This is another example how why Aussies love investment property and negative gearing. You can achieve strong net wealth growth and tax offsets - a double whammy. This also shows that a negative gearing strategy can be applied to other asset classes.

Investing in ETFs is a way of achieving negatively geared investment in the share market. A core benefit of ETFs over individual stocks in this content is diversification - reducing risks. The risk of investing in a Sydney property and the SPDR ETF was similar in the 10 years. Sydney property prices had a standard deviation of $83K, whilst the SPDR ETF measured in at $84K.

On the face of it, investment property seems to be a more compelling investment class. They offer higher returns, more tax offsets and lower negative cash flow. However, I didn't account for a few things that are negative for property investments:

• stamp duty and other taxes;
• vacancy risk - if you can't rent out your property you get no income;
• significantly higher legal fees;
• higher transaction costs when you sell the asset, real estate fees of at least 1%.

The high cost of entry is also a critical issue for investment property. Currently, 1-in-3 Sydney suburbs have median home price of more than $1M. The initial cash deposit required is well north of $100K. For younger investors, this is a tough ask – an idea of reaching that deposit sooner is HERE.

Younger investors can explore the benefits of negative gearing through other asset classes. The asset must be able to achieve higher capital growth than the interest cost. One obvious option is the stock market, which usually delivers higher long term returns than all other asset classes. If negatively gearing the stock market is an interesting strategy, an investment in index based ETFs are a good option to start.

Do you negatively gear the stock market?  Share your thoughts in the comments below!

Jeremy Kwong-Law (@jeremykwonglaw) is Cofounder of www.BetterWealth.com.au. He is a former investment banker turned technology entrepreneur, a muru-D alumni (Telstra startup accelerator). Passionated about leveraging technology to provide better financial products & services to consumers. Coffee snob, business book reader, and fitness fan.

How do you keep track of your share trades?

It's coming up to tax time and normally at this time of year I write a post on how you should start to think about your tax time affairs and start to get your affairs in order.  This year however I'm going to do something different.  I'm going to present a problem that I have...the solution I current use...and see if you have a better solution to this problem.

Problem: I don't have a good system of keeping track of my share trades for tax purposes

One of the biggest problems I have as someone who buys and sells shares is keeping track of the trades for tax purposes.  

It's not that I don't record every transaction that I make - I do and I am meticulous about it.  The biggest problem is working out the tax implication of every sale that I make.

The problem I have is keeping track of working out what is the optimal parcel of shares to sell and the number of shares remaining in the parcel

The problem really exists where you have bought shares over a period of time, either through dollar cost averaging your way into a stock or when you have been participating in a DRP and have been accumulating shares

I FINALLY made money from a Share Purchase Plan

If you have been reading this blog for a few years now you will know that I almost always get shafted when it comes to share purchase plans (or SPPs).  My investment rationale is always sound however I am always shafted by the mega scale backs that come with guaranteed profits.

Interestingly this time I ended up with a larger profit because the end result wasn't as guaranteed as in the past.

A recap on how to make money from Share Purchase Plans

I have gone through this in a significant amount of detail before but basically you make money from share purchase plans because

• You are able to buy shares at below the current market price (often in excess of your pro rata entitlement)
• If the current market price is higher than your purchase price from the share purchase plan you have made an (almost) instant profit

Basically the bigger the discount is to the current market price the more certain you are of making a profit.

However the big downside to SPPs (as I mentioned above) is that because the profit is so certain everyone wants to take part and everyone applies for their maximum allocation.  Companies often don't need this much money and scale back your allocation significantly.  They also don't issue the shares for a long time and take even longer to return your money.  You therefore lose out by having lost the ability to earn interest on this cash in the interim.

I participated in the recent Macquarie Group SPP...even though the terms didn't look as good

Macquarie Group (ASX: MQG) recently decided to do an institutional equity raising and an SPP to raise cash for a purchase that they had done.  When I first looked at this deal it didn't look great at all:

• Macquarie's share price was already incredibly high.  
• I was actually looking to sell out of my MQG shares after years of holding them
• A high share price isn't great because it can go anywhere in the time it takes for you to be allocated your shares and able to sell them
• The discount was tiny
• The higher the discount the higher the guaranteed profit.  In the case of Macquarie SPP it was only a 1% discount which is not really worth your time and effort (especially if you think the stock is expensive)
• They weren't actually issuing that much capital
• Relative to the size of Macquarie this was actually a really small capital raising.  In smaller capital raisings you are more likely to get scaled back which is the thing you want to avoid at all costs

This deal on the face of it didn't look that good...so why did I participate?

There were a few key points in the fine print which caused me to participate in the deal.  They included:

3 things to consider before investing for dividends

There have always been investors  for whom dividends is the most important element of a share investment.  Growth in share price has not been their primary concern.  Some bloggers (such as Dividend Mantra) have their whole investment strategy built around dividends and replacing their income and achieving financial independence through them.

In the current low interest rate environment this approach has become much more common.  Investors have not been able to get the yield they desire from term deposits and online savings accounts so they have turned to high yielding shares (such as banks and infrastructure shares) in order to get the yield they desire.  Why would you invest in a bank account at 2.5% p.a. when you can easily invest in a bank and get a 5.0% yield on a commercial bank or infrastructure stock?

A problem occurs when some investors look at these stocks and their dividend yields like they would a term deposit which is completely the wrong way to go about it.  This post will try and highlight some of the things you should be looking out for when you invest in stocks for their dividend yield.

Things you should consider when investing for dividends is your focus

There are risks when investing for dividends is your primary focus especially in an environment like this.  Below are just a few of the questions you should be asking yourself whenever you undertake an investment like this

1. If interest rates revert to more 'normal' levels what will happen to the value of this stock?

A lot of high dividend stocks have been driven up in price as people search for yield outside the fixed interest sectors.  If interest rates return to more 'normal' levels and people no longer have to invest in these stocks to get the yield then the value of your investment in these stocks may fall.

This is a function of the current market that you can't avoid and is a risk you need to know that you're taking on by investing in high yielding stocks.

2. What is the outlook for the company that you are investing in?

Dividends can be cut.  It actually happens far more

Is the currency play finally over?

Almost exactly 3 years ago I wrote a post arguing that there was an opportunity to invest in foreign index funds (as an Australian investor) because the exchange rate was far higher than it's historical averages and it seemed to me that this state of affairs wouldn't last forever.

My feeling was right and I have ridden the currency down almost 30% in the last ~5 years (this is before considering the returns that I managed to achieve by being invested in those foreign share markets).  I reassessed these investments 18 months ago and although I had already done very well out of them I felt like it still had further to go.

I'm still holding my foreign investments...but the currency is far closer to fair value

I'm still holding my foreign currency investments and they now account for just under half my share portfolio.  With the AUD / USD exchange rate sitting around the $0.82, I no longer have a strong conviction on the value of the currency.  It may be over-valued (I suspect that it might be a little bit strong) and it may be undervalued....I just don't know.

The currency play is finally over

Review: Flash Boys by Michael Lewis

I love reading Michael Lewis' books - they are almost never dry (which financial books can often be) and he has a particular skill of weaving technical information in with the human experience to create a story out of something that most people would have trouble relating to.

This is exactly the kind of book he has written with Flash Boys - a book dedicated to exposing the rise of high frequency traders and exposing an industry which most do not understand and fewer have an interest in exposing.

What is Flash Boys about?

Flash Boys is the book to read if you are a lay person looking to understand how High Frequency Trading works.  It goes through the industry participants, how the board has been tilted against investors in favour of high frequency traders and how you (as an individual investor) and large institutional investors are being screwed by the stock market which is meant to be clear and transparent.

So what is High Frequency Trading?

I don't want to ruin the book and get into the specifics because it can be extremely complex but broadly speaking high frequency traders have better and faster information than anyone else in the market and can use this information to trade faster than anyone else and make a profit in the market based on this information.

Most people don't understand High Frequency Trading because they don't understand how the stock exchanges are actually set up.  They don't realise that most stocks are actually traded on multiple exchanges in a market.  Why does this make a difference?  Say you are looking to place a large buy order of shares in a market.  Your broker sends it to exchange 1 and exchange 2 both at the same time.  The high frequency trader sees it at exchange one (because your electronic signal gets there first) and then gets to exchange 2 ahead of you (because your electronic signal takes slightly longer to get there) and pushes the price up so you are forced to pay more.  They are effectively front running you...and the system is designed to let them do this.

You as the investor get screwed because you are forced to pay a higher price than you would if you could have gotten all the shares at the market price.  Although this affects large shareholders more than small investors the reality is that even as a small investor you end up paying more for your shares than you have to.  The difference can be tiny but these tiny amounts add up to huge profits for high frequency traders.

I won't go into more detail - but will let you read the book.  It is a fascinating expose on a little talked about industry.

This book is great for any one interested in the share market...but it will not make you a better investor

I generally love books which

Scale backs...why do you bother me so?

I recently wrote a post outlining my dilemma about investing in the most recent QBE share purchase plan.  I had already been stung once by a massive scale back and I wasn't keen to go through that experience again.

I phrased my dilemma as 'fool me once shame on you...fool me twice shame on me'.  As it turns out I was fooled twice and this time the fault is definitely my own.  However that being said it wasn't nearly as bad as last time.

I used my last experience to inform my decision this time

While it is true that you can make a lot of money from Share Purchase Plans, it is also true that you can effectively lose money if you get scaled back significantly.  I had experienced a significant scale back on the last QBE SPP and so was very aware that this could happen again.

Investing is all about learning from your previous experiences, and also from your previous mistakes and I was glad to learn from that previous mistake because it informed my decision making in the most recent share purchase plan.

I didn't apply for as many shares

In the last QBE SPP I applied for the maximum amount of shares (set at $15,000) in the hope of maximising my profits.  When I got scaled back this also resulted in me having the greatest opportunity cost loss.  I realised that this could happen to me again and so I only applied for the smallest possible parcel ($5,000).

Why did I do this?

1. I wanted to

I lost money on the last Share Purchase Plan...do I try again?

"Fool me once...shame on you;  Fool me twice...shame on me".   That old proverb is ringing in my mind as I try and decide how much money I want to commit to the QBE share placement plan (SPP) that was announced in mid August 2014.

This is not the first time that I have had to decide to participate in an SPP run by QBE Insurance.  The last time was in 2012 and I saw an opportunity to make a nice little profit.  However, as I documented on this blog I got scaled back to such an extent that I actually made an effective loss if you account for the amount of time that they held my money before returning it.  I had applied for $15,000 in stock but received a paltry $32.10 and had the rest of my cash refunded to me.

A quick refresh on how to make money from Share Purchase Plans (SPPs)

I thought I would quickly run through how you can make money from share purchase plans.  In fact it is quite similar to making money from a rights issue:  You don't make the money from taking up your rights - the share price should adjust for this.  You make your money from the difference between the price at which you buy the shares and the theoretical price the shares should trade after the raising.

For example.  Assume Company A is trading at $10 per share and there are 100 shares.  

• The issued capital of the company is worth $1,000
• Assume that it wants to raise another $500 for acquisitions so it taps it's shareholders for some more money
• The shareholders aren't necessarily going to give the company all of the money that it needs so the company issues shares at a 50% discount to the current value (i.e. for $5) per share.  It needs $500 so it is going to issue another 100 shares
• The company now has an extra $500 of cash and an extra 100 shares.  Therefore the company is worth the original $1000 + $500 = $1,500 and there are now 200 shares on issue making each share worth $7.50
• This $7.50 is the theoretical price the shares should trade at after the raising is done

So how do you make money

Always know why you are invested in a stock...and at what price you would be willing to sell

I rarely make blanket statements on this blog about investing.  I think investing is inherently nuanced and specific to the individual making that investment bias.  However there are some rules which you should never break in the investment world and today I am going to talk about one that I constantly break and which makes me a worse investor as a result.

Here is the rule:

If you invest directly in the share market you should always know why you are invested in a particular stock and at what price you would be willing to sell that stock

 Know why you are invested in a stock

Knowing why you are invested in a stock is very different to knowing why you invested in a stock in the first place.  

Last year I wrote a piece on Reasons and Tips to stay on top of your existing investments and it is as true today as when I wrote it.  That post argued that we are programmed to care about things that are:

1. Exiting (i.e. new investment opportunities)
2. Painful (i.e. investments that are going very badly)

However all to often we don't really care about those investments that hadn't done anything.  The companies could have changed substantially along with their risk profile and the opportunities associated with it however we do nothing because in an investment sense they have not done anything to cause us to turn our attention to them.

Having an investment thesis for

Investment Basics: What is the P/E ratio?

Any investment book that deals with stocks (see a few of my recommended ones here) will mention the P/E ratio of a company (Price to Earnings Ratio).  Most of them take it for granted that you know what it means and if they do explain it, it tends to be at a very high level.  This post will break down the P/E ratio so that the next time you are looking at a stock you know what you are actually looking at when you look at the ratio.

The P/E ratio is a relative measure of how expensive a stock is

That's actually all a P/E ratio is.  People often assign all sorts of interpretive power to a P/E ratio but in fact it provides nothing more than a tool for comparison with other companies.

The P/E ratio of a company looks at the price you are paying for every dollar the company earns.  I will go into more detail about how the P/E ratio is calculated and what it is and isn't useful for below:

How is the P/E ratio calculated?

Of all the ratios that investors use to value stocks, the Price to Earnings ratio is one of the easiest to calculate.  It is simply:

The price of one share in the company / The earnings per share of that company

Each of these is reasonably easy to find:

• The price of the share is usually stated on a stock exchange and it is easy enough to look this up on the internet
•  The earnings per share is usually stated in the companies earnings report (it is normally highlighted because they know that investors look for it

What does the P / E ratio mean?

This is the part which most people trip

Review: One Up on Wall Street by Peter Lynch

One Up on Wall Street is an investing classic and a book that every small investor should read.  I first read this book when I was starting out on my investment journey and I re-read it again before writing this review.   If anything I liked this book more the second time around as I more information, more context and I was more used to investing in stocks.

Who is Peter Lynch?

When it comes to books on investing I think the author is incredibly important.  I like authors to have  track record in the real world of investments.  I would rather take advice from someone who has been there and done than in a very public and scrutinised way rather than those who say that they have earned significant returns using some strategy or another.

Peter Lynch has everything that I look for in an author even before I start reading his book.  His investments were incredibly public (he headed up the Magellan fund at Fidelity Investments) and his returns were spectacular over a long period of time (he averaged a return in excess of 25% between 1977 and 1990).

This book is all about teaching you how to beat Wall Street

I know that there are a hundred books which all claim to do this same thing but Peter Lynch's approach is both practical and insightful while at the same time not being overly simplistic.  Basically his formula for success for small investors is as follows:

1. Know the weaknesses of Wall Street (or of large institutions generally)
2. Don't try and beat them at their own game
3. Use the information you personally have to give you an edge 
4. Don't forget the fundamentals of the stock you are investing in
5. Know the type of company you are investing in (fast growing, turnaround etc.) and tailor your investment in that company to suit (i.e. know when you should both buy and sell these companies

Obviously the book is much more detailed than what I've outlined above but it is incredibly insightful.  Although all the points above are important I really think that points 1 - 3 three are what set this book apart.  Most investment books will

I invested in a fraudulent company and lost my money...here is what I learned

Things don't always go to plan when you invest in individual stocks.  Some stocks will make you money and others will lose you money.  This post will cover an investment I made two years ago (and which I wrote about on this blog) which went sour and where I lost my whole investment.  I will cover why I made the investment, why it went south and most importantly what I learned from the whole process.

What was the stock and why did I invest in it?

Almost exactly two years ago I invested in a company called Kinghero.  It was a German listed, Chinese manufacturer and fashion retailer aimed at the growing Chinese middle class.  I invested in it for several reasons:

1. The industry was appealing
• Getting exposure to the

Why do companies get away with acting badly? Here is my way to effect change!

Corporate governance is important and can really affect share valuations.  The problem is that as individuals we can make very little difference (even if we do vote at shareholder meetings).  Retail shareholders typically do not have sufficient influence to change the way in which a company acts - as we are dwarfed by institutions.

Why don't most institutions hold companies account for their actions?

Large institutions can definitely make a difference.  However they often don't pull companies up for their bad actions or behaviours for various reasons:

1. The want access to the companies
• Institutional investors are researching these companies day in and day out and one of the ways they do this is by access to the company's board and management teams
• There is always the risk that you lose this access by 'rocking the boat' too often and voting against what the board and management teams want to do
2. They make money when some of these companies do badly
• The performance of a fund manager is often measured on a relative basis versus an index
• Even if a fund manager holds shares in a company which has bad corporate governance practices and can therefore make a difference through their voting, if they are underweight the stock they get rewarded (in performance terms) if that stock does badly
3. They get no positive benefit from holding companies to account
• If you invest in managed funds, ask yourself "when was the last time I made a decision about which fund manager to invest in based on how activist they were in terms of looking after my investments?"
• The fact is that the clients of fund managers do not care enough about corporate governance to make the fund managers care.  As a result fund managers just focus on making more money 
• If the return of a stock is likely to be impacted by corporate governance issues then they will be underweight the stock which creates the issue outlined above

The case for index funds to be corporate governance hawks

Index funds are the one actor in the whole share market who has the best incentives to

Review: You Can Be A Stock Market Genius by Joel Greenblatt

With a title like "You Can Be A Stock Market Genius" I was expecting this book to be full of marketing hype and not much actual substance.  I thought it would be full of tips on investor psychology (which is actually very important) but very little on how to invest (which is what we all want to know).

For the second time in a row (the last time was The 4-Hour Workweek - see my full review) I was pleasantly surprised.  This is the first book written by Joel Greenblatt, the founder of Gotham Capital and although he later admitted that it was probably to advanced for the beginner investor.  This book is brilliant if you have been investing for a while, understand how stock investments work and how you generally look at companies to value and have been wondering how successful investors actually spot opportunities in the market.

What sort of investments does the book cover?

This book is probably best described as a special situations investment book.  It covers a variety of special situations which consistently deliver stronger than average returns and it goes through how these situations work, why they deliver the returns, what you need to consider and most importantly also backs up every situation with relevant examples and evidence.

The special situations the book covers include:

• Investing in spin-offs and rights issues
• Risk arbitrage and merger securities (although advises not to try this at home)
• Bankruptcy and restructuring investments
• Recapitalisations, LEAPS, Options and Warrants

One of the best thing about reading this book is that Greenblatt goes to the effort of explaining to you what you, as an individual investor, should look at and what you should avoid.  This is invaluable.  Most investment books provide explanations but not actually what you as an individual investor should do.

Does the invest advice actually work?

Everyone provides

The challenge of tracking your portfolio returns

As you can probably guess from this website - I am a person who likes tracking everything.  I track my financial goals, I track my weight, I track my savings, I track my expenses.  It was therefore rather disconcerting when I found myself wanting to write a post on my 2013 share portfolio return and I was unable to dissect what it actually was.

If your portfolio positions are not static your returns are harder to track than you may imagine

If for any reason your portfolio composition changes, tracking your overall portfolio return becomes a real challenge!  You cannot just take the starting value of your portfolio and then the ending value and then work out what your percentage returns are for several reasons

1. If you have contributed cash into your share account then your returns are going to look a fair bit higher than is really the case
2. If you have sold shares and withdrawn cash then your returns are going to be depressed
3. Any dividends that are not re-invested should count towards your returns however are not going to be using this method
4. Transaction costs should factor into your portfolio returns

All of these challenges are surmountable however if you try and do it in hindsight it is close to impossible.  I tried to do it for 2013 so I could write a post on my 2013 portfolio return and after a day of effort I realised that it was just far too much effort.

If you want to track your portfolio returns therefore, you need to set up a method of doing so at the start of your tracking period which takes into account all of the issues above.

Treat your own portfolio as a fund manager may treat theirs

The best way I found to

Share Sale Facilities: A great exit opportunity

Occasionally, as an investor, you may end up with a small parcel of shares in a company.  You may end up with this as a result of a share issue by your employer, due to a corporate action in another share you may own or you may even have shares gifted to you.

These small parcels of shares are often annoying...

They are annoying for several reasons

1. They are annoying to sell because trade costs are often fixed up to a certain limit.  
• On a $300 parcel of shares therefore you may be paying ~$30 commission - i.e. you need a 10% return on the shares just to break even
• A friend of mine got an allocation of shares from his part time employer valued at about $300 and he could choose to take them as shares or to sell them through a share sale facility - he thought the shares may go up over time - however he had totally forgotten to take into account the return he would have to get just to make up his transaction costs
2. You may not want to hold them in the first place
• Sometimes a company will spin off a

Reporting Season: Are you keeping up?

Every six months I write a post complaining about reporting season (that time of year when companies report their results to the market) - it's normally the time of year that I am the busiest and when my hard effort at the gym for the rest of the year gets undone.

But it is also the most interesting time of the year - it tends to be the time of the year when you get lots of new information on companies.  Why is this important?  Because when you invest in companies this new information can really move the valuation dial so you should really be keeping up.

A reminder from the past - don't make rash decisions

The danger with a whole heap of new information is you get out there and start trading on this information before you really process what it means and how relevant it actually is.  Decisions about trading never have to be made so take your time to absorb all the information.

But make sure you actually get the information

Even if you don't trade on

Golden Rules for Share market novices

One of my good friends, who has never invested in the share market recently opened a trading account and was looking to invest in basic index ETFs as a starting point but then got very nervous when they saw the share market falling.  I found myself writing a long email to them about the psychology of investing and I thought I would replicate the tips here.

Here are some golden rules that new investors should stick to when investing in the share market.  These may seem basic to experienced investors or if you have been trading for a little while...but if you are a new investor I suggest taking them on board.

Golden Rules for Share market novices

1. You never have to trade
• There will always been good deals available and although some will be better than others, deciding to buy or sell without thinking through your decision because of something you've heard or seen is almost always a bad idea
• You never have to trade - there will almost always be another opportunity
  
2. Stop checking your portfolio every day
• Unless you are a full time trader you have no reason to check what the price of your investment is doing every single day - it will  just stress you out
• Share markets move up and they move down.  Stay on top of the fundamentals of your investment but if there is no new news ignore what the share market is doing
  

Selling at a loss hurts...but lazy capital hurts more

Towards the end of last year I wrote quite a long post on the need to constantly re-evaluate your portfolio.  The chances are that you do not understand why you are holding onto every one of your stocks.  Worse, there may be some stocks in your portfolio which you know are never going to recover but which you hold onto because the original thesis (which was great) never panned out and you now have lazy capital.

Just because a share has decreased in value does not mean it is a bad investments

An investment thesis almost never plays out straight away.  If you buy a share or other investment and it goes down over the next few weeks or months don't stress about this - if your thesis still holds and you have confidence in it, then have the courage to stick by it.

An investment thesis can sometimes take years to play out but the rewards are there at the end - one stock I owned kept falling for almost 2 years but I still believed in my thesis and then within the space of a few months it more than doubled in value from my original buy in price on the back of that thesis.

Where your thesis has not played out...and you have turned out to be wrong then it is better to admit your mistake quickly

The first step is to stay on top of your investments.  If you have invested in a stock that seems undervalued and then the market fundamentals of that stock deteriorate rapidly then it is better to admit your mistake quickly.  Several years ago I invested in Fairfax Media (ASX: FXJ) on the basis that the stock was trading on an extremely cheap multiple - implying that the market expected print media to go out of business rapidly (i.e. a significant earnings deterioration in a very short period of time).

I thought that the market was over-doing it and I invested in the stock at $0.99 per share on the basis that I thought that it was worth at least $1.20.  In hindsight the market was completely right and I was completely wrong.  The stock very rapidly declined in value, with earnings being eaten away much more quickly that I expected and before long the stock was trading in the mid $0.30 range.

The dilemma I then had was that the stock once again appeared to be

FKP's rights issue made me a tidy profit

This is just a quick post to update you on one of my investments that I have written about on this blog.  I wrote recently about how I had participated in the FKP equity raising through their rights issue.  I took up my rights and I applied for an over-allocation.

The allowed application for an overallocation was $100,000 however given that the share price was trading at a significant premium to the issue price I figured there would be a massive scale back.  The last time there was a big scale back (in this very stock) I got quite lucky because my broker allocated me much more than I would have received had I held the stocks in my own name.

Below I have outlined how I made my investment decision, what I applied for and what I ended up getting.  I have not yet been able to sell the stock because my work has a minimum holding period for stock trades (which is very common if you work in the finance industry).

A walk through of my investment rationale

First and foremost in an equity raising you need to look at:

1. Is the company going to go broke?
• When companies do equity raisings (especially to pay down debt) there is a chance that they are going to go broke anyway 
• This is the first thing you need to think about before rushing into an equity raising
2. Does the price represent a good deal for you?
• If you do not participate in an equity raising you are going to get diluted (especially if the equity raising is non renounceable - i.e. you can't sell your rights) so if the company is not going to go broke you would normally want to take up your rights
• You need to think about the fundamental value of the company you are investing in and whether it represents a good deal to invest more into this company

The FKP equity raising looked particularly compelling because: