Buying dividend shares like Telstra Corporation Ltd (ASX: TLS) or Commonwealth Bank of Australia (ASX: CBA) might not seem risky – but it is, in more ways than one.
Riskier than term deposits?
Term deposits of less than $250,000 with a reputable Aussie bank could be one of the safest 'investments' you'll ever make. I say 'investments' because it's not really an investment, it's a saving. But, chances are, the term deposit is protected by the Australian Government guarantee.
But everyone knows shares are riskier than term deposits!
And most of us know that dividends are not guaranteed – although they are reasonably consistent.
Finally, some of us know that a share's 'risk' is often measured by its beta. In my opinion, beta is complete nonsense for anyone that truly is a long-term investor.
For example, Telstra's beta is 0.74 while NAB has a beta of 1.8, which means NAB is 'riskier'. But the beta measures what happened in the past – it says nothing about the future.
The biggest risk to buying shares
Here's where this discussion gets interesting…
Few 'experts' will tell you this, but there is a bigger risk to buying ASX shares.
Many of us might argue that this is the biggest risk you'll face:
Is it worth picking shares at all?
You see, the 'pros' want you to pick individual ASX shares because it keeps them in a job. I get paid to tell you which ASX shares I think are good, bad or downright ugly, for example.
And you want to read about it because our brains are wired to think that there is such a thing as 'superior performance'.
We think: I can do better-than-average if can I find the 'good' shares.
Behavioural psychologists call it the illusory superiority (aka: a better-than-average bias). It happens when we overestimate our ability to do something better than everyone else, like buying 'good' dividend shares.
But what many of the pros fail to tell their clients is that actually picking shares might not be worth their time. We've all heard the finding that 80% of professional investors do worse the market over the long term.
But some, perhaps lesser known, academic research, such as that by Brinson et. al and Ibbotson and Kaplan (2000) suggests that most of the return from an investment portfolio over time comes from a long-term asset allocation policy.
In English, these studies found that if you invest regularly and stick to a weighting of local shares, international shares, cash and term deposits and property, most of your return will come from investing in the asset classes — not the individual shares you pick.
For example, your super fund might be weighted to 30% ASX shares, investing in a low-cost index fund to get the exposure. When it climbs to a 40% exposure, the portfolio is 'rebalanced' so that the shares account is again at 30%. Note that this strategy doesn't actually involve picking shares, it just sets a policy and sticks to it.
Using this strategy has been found to explain 90% of all investment returns over time. The other 10% comes from 'timing the market' and picking shares.
Foolish Takeaway
Investing in shares (and property!) is risky compared to other assets like term deposits and fixed income. Not only that, there is a chance you are wasting your time by even trying.
My advice for all investors is to invest in index funds and ETFs, as well as a small portfolio of individual shares which you manage or outsource to a professional who runs an actively managed fund. That'll help satisfy our monkey brains.
And if, after some time, you find that your active portfolio isn't doing too well – just stick all your money in the ETFs and index funds, kick your feet up and relax.
