Investing in shares certainly isn't for everyone.
They can be difficult to understand, and are amongst the most volatile investments around. Every year, dozens of companies crash and burn, irrevocably, sending millions of dollars of investor capital up in smoke.
More than a few investors have gotten their fingers burnt playing in the market — some very badly.
So although shares may offer the best long term average return — an undisputed fact — for some the upside isn't worth all the trouble. And that is understandable given the bad press shares tend to receive.
(In fact, most sharemarket news tends to be bad, probably because bad news sells much better than good news!)
However, for those able to take a deeper look, things aren't nearly as risky as some would have you believe. The first thing to keep in mind is that not all shares are created equal. Just as the good people at Castrol claim that "oils ain't oils" we can also rightly state that "shares ain't shares".
Apples with Apples
There are approximately 2,000 listed companies on the Australian Stock Exchange (ASX), which belong to dozens of different industries and operate in a wide variety of markets.
Saying "all shares are risky" is like saying "all animals have 4 legs." It's true in a lot of cases, but such a broad generalisation is far from accurate.
A speculative minerals explorer, which has yet to make one cent in sales, is aworld away from a multibillion dollar supermarket operator, with consistent and attractive profits.
Even if you exclude the small start-up operations, there are very big differences amongst even the larger well established companies on the ASX.
Rio Tinto Limited (ASX:RIO) is the world's second largest miner, it makes billions of dollars each year and even pays a reasonable dividend. But it bears little resemblance to CSL Limited (ASX:CSL), a biopharmaceutical giant that manufactures a wide array of medical products. Both are amongst the top 20 largest companies on our market.
Rio's profitability is largely dictated by what's happening on commodity markets. Things can go really well when the price of iron ore is high, but profit can take a real beating when prices start to head south — as some investors are now starting to discover.
Had you invested in Rio Tinto 5 years ago, you would have barely broke-even today, even after accounting for dividends. Sadly, even if you go back ten years, and capture the performance of Rio when the mining boom was in full swing, the average shareholder return is less than the broader market average.
Contrast this with CSL. A business that has extreme pricing power, is virtually recession proof, and enjoys wonderful levels of profitability. Even the GFC failed to make a dent on profits!
Anyone who invested in CSL 10 years ago would have more than doubled their money. In the past 5 years alone, the total shareholder return has been over 52%.
Of course, in the short term, shares in both Rio and CSL will seem equally volatile. In fact, shares in CSL dropped nearly 8% in just one day a couple of weeks ago! But volatility isn't what makes some shares riskier than others. In the long term, shares are only as risky as the business they represent.
I'm sure both Rio and CSL will both be around for many years yet. I'm sure both will see some pretty wild swings in value. But I'm also pretty sure that in the years ahead, the CSL business will continue to generate far better returns, will continue to pay out steady and rising dividends, and will continue to represent much less risk than any miner, even the big ones.
Speaking Of Dividends
Of course, these days, with record low interest rates, dividends are front and centre of investors minds — and rightly so!
But those that are able to overcome the notion that "all shares are risky" will still come undone if they think "all dividends are the same", and focus purely on yield.
If we stick with Rio and CSL, we can see that the former offers a 4.1% fully franked dividend yield, while CSL is quoting a rather uninspiring 1.3% yield, unfranked.
What the yield doesn't tell you is the reliability and growth of dividends.
Rio has been forced to reduce its dividend twice over the past decade. CSL has only ever increased its dividend.
Rio has managed to grow its dividend by an average of about 3% per year since 2005. CSL has increased its shareholder payout by almost 23% per year, on average, since then.
Little wonder that CSL shareholders have received more dividends, per dollar invested, than Rio shareholders over the past decade. Despite its significantly lower yield, it has been a far better income investment!
It's exactly those types of opportunities I hunt down for subscribers to my Motley Fool Dividend Investor stock picking service.
Take, for instance, my latest Motley Fool Dividend Investor recommendation, a company whose business is extremely resilient to the ups and downs of the economy, and that is offering investors a pre-tax dividend yield of about 8%.
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Your greatest risk
Shares are a great investment for those looking to safely build long term wealth — in my mind the best way.
Yes, there are risks, but as Warren Buffett likes to say, risk comes from not knowing what you are doing.
- If you are going to chase exciting speculative companies — you will be taking a huge amount of risk.
- If you plan to trade in and out of shares and profit from the ups and downs of prices — you will be taking a huge amount of risk.
- If you expect to do well simply by chasing those companies with the highest yield — you will be taking a huge amount of risk.
- If you plan to buy into companies for which you have little understanding as to what makes them tick — you will be taking a huge amount of risk.
On the other hand, if you invest into quality companies with attractive characteristics, and buy at sensible prices, with a view to hold on for the long term — you are at serious risk of generating some very attractive returns!
