Investing in the share market can be a daunting experience particularly for novice share market participants. Many people consider the share market to be too risky and steer clear of it.
The share market is a place of opportunity but also a place full of pitfalls for many.
The share market is the most volatile asset class but on an unleveraged basis, history has shown that shares are the highest performing asset class.
Smart investors wanting to diversify across many asset classes know that while they want to capture the benefits of investing in the share market, the percentage of their total wealth invested in the share market should be relatively small to offset the level of volatility within the share market.
Despite the volatility, smart investors want the benefits of investing in shares such as capital gains, income from dividends and the franking credits associated with dividends that can reduce their tax bill.
Not all but much of the risk of investing in shares can be mitigated by investing in only the best businesses listed on the market. When you own shares in a company, your investment return is not a function of the whole market but the investment performance of the company you own shares in.
The best companies have a history of high profits, good dividends, strong cash flow, little or no debt and a bright outlook for the future. Buying a diversified portfolio of shares in companies with these attributes significantly reduces the risk of investing in shares.
Therefore, it makes sense to invest in the best performing companies listed on the market and by doing so, you give yourself the best chance to outperform the market.
What are the characteristics of the best performing businesses?
- They have a long history of high profits
- They pay fully franked dividends that rise steadily each year
- The business has strong and positive cash flow
- The business has little or no debt
- The business has bright prospects for the future.
How can you find out which companies are the best performers?
Trading platforms such as CommSec and eTrade as well as the ASX website have free tools on their websites that allow people to search and narrow down this list of criteria to a small list of companies with these performance characteristics.
When to buy?
This is an age-old question and best decided after you have decided which high performing businesses you want in your portfolio.
One way is to make volatility your friend. The recent Brexit issue in June and July created volatility and saw the Australian share market as-a-whole fall 10% in a matter of weeks. Some of the best performing companies fell 15 to 20% during this time.
After the volatility subsided, this gave the opportunity to buy shares in great businesses at low prices. Using volatility is a great way to buy low.
The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.