In a previous article on why you should invest in the Sharemarket, I gave my top 10 tips for DIY share market investment.

One of my tips was as follows:

“There are innumerable share purchase recommendations for free and there are many individuals and organisations that provide recommendations to paying subscribers. They can be a valuable source of guidance and information but don’t follow them blindly. Do your own homework and come to your own decisions.”

Clearly some recommendation services are better than others, and I didn’t want to bias the article with my own personal opinions on the matter, particularly as there are probably some great services out there that I have never used and some that I have not even heard about.

I’m sure I’m not the only one who’d be interested to hear what services others are using and what they think of them, so here’s your chance to contribute!

Please post your comments on which services you subscribe to, how closely you follow their recommendations, what you think of them and why.

Things got seriously out of hand as we are all now painfully aware and America turned to its economic policy advisers to come up with a solution. Unfortunately what they came up with left a lot to be desired.

Their solution was to grab $US700 billion of tax payers’ money and buy bad bank loans. This would have been grossly unfair to taxpayers who were basically being asked to pay megabucks for a load of worthless junk with no compensating upside.

Fortunately the European Union and Britain were alert to this inequity and came up with a much more reasonable, if blindingly obvious solution. If tax payers’ money had to be used to bail banks out it should be used to purchase equity in the bank. That way, long-suffering taxpayers would get a commensurate share of the good stuff as well.

Eventually, the wisdom of this proposal dawned on the Americans and they announced that they would follow the European and British lead. And what happened when they finally got it right? A few billion (or was it trillion?) was promptly wiped off the American share markets! So it’s not just the banks and economic policy advisors in America who seem to have lost the plot.

And the point is? Well, the Americans led us into this mess but, based on their performance to date, we would be foolish to expect them to lead us out.

Here’s my take on the situation. Caveat: I might change my mind next week!

There is no doubt that there is going to be a major reorganisation of credit globally.  The consequences of such a massive change that will embroil the Government (and quasi-government organisations) so extensively in the financial markets, are impossible to predict.  However history suggests that anomalies, distortions, loopholes, exploitation and ever increasing complexity and cost will rule.

Despite this gloomy prediction, I also think that while the process of restructuring the world’s financial markets is occurring, the productive sector will quickly get back to something approaching normalcy.  In other words the players will soon stop obsessing over the score and start concentrating on the game.

Clearly Australia will not escape the impact of the credit crisis or the effects of the recession that is likely to hit most of our trading partners. In view of this it is slightly surprising to me that PM Kevin Rudd has predicted 2% annual GDP growth and that this is supported by similar predictions by the big 4 banks.  In fact Westpac is predicting GDP growth of 2.8% over 2008 and 2.2% in 2009.

Whether these predictions prove to be unduly optimistic remains to be seen but there are good reasons to believe we will be less severely affected than most.  Unlike many countries we have not had major bank collapses, our financial system has not been hijacked by out-of-control derivatives trading and the Reserve bank has more latitude than most its overseas counterparts to provide further stimulus via interest rate cuts if necessary.

And there is further reason for optimism as well.  According to Westpac CEO Gail Kelly http://www.theaustralian.news.com.au/business/story/0,28124,24578232-30538,00.html

who should know if anyone does, Australian banks, in contrast to their counterparts in the US and Britain, have been more conservative in their lending over the past decade. She claims that there has been little or no sub-prime lending by the major banks, and that average loan-to-value ratios are remarkably low.

So back to our share market. What might all this mean? I believe it will be good news. Our economy will be less severely affected than most and this will enhance Australia’s reputation as a sound place to invest. This in turn will re-stimulate investment in our share market from both local, and more importantly, offshore investors.

This is not to say it will not be much tougher than it has been over the past 10 years or so.  For a start, lack of international demand is likely to depress oil, iron ore and coking coal prices. However this is already fully reflected and more in the share prices of the likes of Rio Tinto and BHP.

For those of us interested in the share market this is surely the key point. The collapse in our share market prices (the S&P/ASX has fallen from 6828 points a year ago to 4018 today) seems out of all proportion given an economy with a sound banking system and forecast growth in GDP that most countries could not contemplate in their wildest dreams.

So how long will it be before common sense prevails and how strong will the bounce back be?  I don’t know, but I have certainly persuaded myself not to give up on the Australian share market.

What are your thoughts?

For some, the thought of investing in the share market is enough to make them go weak at the knees or worse. It conjures up thoughts of gambling and crippling losses. And it reminds them of the only two years in recorded history that they associate with a financial event: the share market crashes of 1929 and 1987. You would have to be nuts to even think about investing in shares.

Wouldn’t you?

Well, no actually. A better definition of nutty would be not thinking about investing in shares. Why? The answer is simple. Shares produce higher returns than other types of assets. Stock exchanges have been around for a very long time and innumerable studies have come up with the same result: over the long haul shares do best.

The phrase ‘over the long haul’ is important because occasionally there can be quite long periods when shares look as if they are not going to deliver the best long term performance.

A major reason that people lose money on shares is that when the market falls, as it inevitably will, they panic and bail out, usually after most of the damage has been done. When the market rises again, as it inevitably will, they are not there to reap the benefit.

When you commit to shares for the long haul you soon realise that it is not about share prices; it’s about companies. If you focus on the share prices you are likely to get caught up in financial ratios, trading strategies and a high-risk game of trying to predict (in reality, guess) whether prices are going to go up or down. And even if you are lucky enough to predict a price rise or fall, that will not help you much unless you can also figure out when. We all know it is going to rain sometime in future but unless you know when, you can’t be sure the washing won’t get wet.

We are not talking rocket science here folks. You DO NOT have to be a financial guru and you do not need a financial advisor to do well in the share market. All you have to do is focus on companies. Look for companies with a proven track record offering top quality products and services that you understand and that you think will be in strong demand well into the future.

Here are my 10 tips for DIY share market investing:

1. Plan to be in there for the long haul.
2. Only invest money that you are confident you are not going to need at a particular time in the future. Otherwise you might be forced to cash up your shares in a downturn before they have delivered the superior return you are looking for.
3. Start out small and increase your investment over the years as your knowledge and confidence grows. That way you also avoid the risk of investing all your money at a high point in the market.
4. Spread your investment over a number of different companies in different industries. For example, if you have $10,000 to invest consider spreading this over, say, 5 companies. Diversify further as your total investment grows.
5. Read articles about companies of interest to you in news papers, magazines and online. You will be surprised how quickly your knowledge and confidence grows. You can use online tools such as Sharesight to check the historic performance of a company to help you with your investment decisions.
6. There are innumerable share purchase recommendations for free and there are many individuals and organisations that provide recommendations to paying subscribers. They can be a valuable source of guidance and information but don’t follow them blindly. Do your own homework and come to your own decisions.
7. Focus on companies not share prices when you make your investment decisions.
8. Don’t panic if share prices suffer a sudden fall. You know in advance that this is likely to happen from time to time just as you know that in the long run shares are likely to give you the best return.
9. Start using a good share portfolio management system such as Sharesight from day one. It’s important to keep a good record of the shares that you own because you will need this information to file your tax return. It’s also crucial that you can easily and accurately assess how well your shares are performing. Sharesight virtually eliminates the administrative work associated with owning shares. All the data you need for your tax return is provided automatically. And, best of all, Sharesight shows you the true, annualised financial return on your shares including capital gains, dividends and currency movements.
10. Have fun! Believe it or not, studies have shown that most DIY share market investors thoroughly enjoy managing their investments.

Innumerable studies have examined the reasons for this remarkable growth. This is not surprising because other countries are eager to learn from Australia’s experience. And from Australia’s point of view it would be great to understand the reasons for this success to help ensure that it continues unabated.

Most of the studies talk about things like economic reform, increasing productivity, innovation and the increasing world demand for Australia’s extensive reserves of metals, minerals and fossil fuels. But all this stuff is pretty old-hat and you could be forgiven for wondering if there isn’t a bit more to it than that. Could it be that Australia has an economic weapon that is so secret that it is not mentioned in any of the economic studies? Either the answer is “yes” or else these studies have failed to uncover a key contributor to Australia’s economic success story.

You’ll think my coolabah tree has failed to keep the sun off my head if I say that Australia’s secret economic weapon is a romance. But it is true. It’s Australian’s love affair with their share market.

According to the ASX’s 2006 share ownership study, 46% of Australians own shares. Although international data is scarce, you can bet your last dividend that few countries, if any, can come close to matching this remarkable performance. When it comes to investing in their share market Australians leave the rest of the world in the shade.

History shows that in the long run shares provide the best return so this romance with the share market creates a win/win/win. The 7.3 million Aussies and their families who own shares win. Australian companies also win because the high level of share investment provides the equity that helps fund the rapid growth that many of them achieve. And through this growth the Australian economy wins as well.

An equally remarkable fact from the ASX study is the DIY attitude Australians take to share investment. An amazing 6.0 million invest directly in shares and of those, 38% invest through an online discount broker and further 15% through a discount phone broker. This is where Sharesight comes into the picture.

Direct, DIY share market investors who invest online deserve a decent, online, portfolio management system. And that is exactly what Sharesight provides. Sharesight is comprehensive, easy to use, and requires minimal data entry. It automatically produces the true, annualised share returns and tax reports that ensure you pay the minimum amount of tax.

But don’t take my word for it; take a free trial. It could be the start of a beautiful new relationship.

An Investorweb customer drew this to our attention recently after discovering and logging onto Sharesight. He wrote to us saying “I was really surprised at the difficulty in finding a replacement, which was is why I was so pleased when I found you site”.

If you are an Investorweb client who is looking for a top-quality portfolio management service we suggest you check out Sharesight by taking advantage of our 30 day free trial offer. We are sure you will be impressed.

Sharesight focuses exclusively on providing a straightforward, affordable and independent online share portfolio manager for DIY investors.

One of the reasons they fail is that providing you with the true, annualised return on your shares is trickier than it sounds. For a start you need to have a large amount of data at your fingertips and you need to be able to account for corporate actions like dividends, share splits, amalgamations and bonus issues because these will make nonsense of return calculations if you don’t.

To further complicate matters, there are two common arithmetically correct ways to calculate returns and in some circumstances they can give radically different answers. The two methods are the compounding method and the simple or non-compounding method.

The easiest way to appreciate the difference between the two methods is to consider a deposit account at the bank. If the bank quotes you a 7% interest rate this is a compounding rate. This means that if you do not withdraw your interest it will remain in your account and you will receive interest on that interest. Under the simple or non-compounding method, interest is calculated only on the original amount invested.

It is clear from the table below that $1000 invested for 10 years at 10% using the simple method does not equal 10% using the compound method. The simple method results in the return of your initial investment of $1000 plus a further $1000 of interest at the end of 10 years, whereas the compounding method results in the return your original investment of $1000 plus $1593.74 of interest. In fact an investment of $1000 that results in a return of that investment plus a further $1000 of interest over 10 years, equates to a compound return of approximately 7%.

To compare apples with apples a compound return calculation must be applied to your share portfolio if you want to compare its returns with a bank deposit. In the example above the correct return to compare to a bank deposit is 7% compound not 10% simple.

So what does Sharesight do?
Until now Sharesight has used a simple return calculation. This method is widely used to calculate share returns. Although it is arithmetically correct, it produces figures that overstate share returns in comparison to a compound return on a bank deposit.

This is why we have introduced a compound return calculation that you can select and apply to all tables in Sharesight that display return information. We use a daily compounding formula as this is standard practice among banks. Although simple interest will remain as the default setting you can choose to switch to compounding returns on a per portfolio basis by editing the portfolio settings (found under the settings link at the top right of the screen). There is also a link to change the percentage return method at the bottom of each page for which compounding return figures are available.

So which is correct and what should you do?
Both methods are arithmetically correct. We at Sharesight do not wish to get embroiled in a debate concerning the merits of one method over the other. You are free to choose which ever method you prefer.

Some more technical information about the formulas that Sharesight uses to calculate returns can be found here.

We also answer some common questions about compounding interest (and a variety of other questions) in the frequently asked questions section of the help documentation, which can be found here.

As with other Sharesight pages you can switch between displaying dollar returns and annualised percentages. The new performance report can be found under the reports menu when logged into Sharesight.

The sold shares report shows capital, dividend, and currency gains associated with shares that have been sold and are therefore not reported under your current holdings. As with the main portfolio page, the return figures in the report may be displayed in dollars or as annualised percentages.

Other recent changes include the addition of a quantity column on the main portfolio page to show the total quantity of shares owned for each holding (by popular demand!). Thanks to everyone who has provided feedback, and please keep it coming!

In my view diversification to that extent is more likely to create retirement cash blues than beat them and would not result in a very effective portfolio. For one thing it is not practical for most investors to diversify to the extent recommended unless they invest in managed funds. And the long-term performance of almost all managed funds leaves a lot to be desired. Even a portfolio of randomly selected NZ and Australian shares is likely to out-perform most managed funds, particularly when their fees are taken into account.

Shares and property consistently outperform cash or fixed interest on a long-term basis (and retirement saving is a long-term project) so why would you want to erode your higher-earning share portfolio by diversifying into fixed interest? There are three main reasons often put forward.

First, diversification allows you to spread risk. The hope is that any poor performance will be confined to a small part of your portfolio.

The second reason has to do with liquidity risk. If you need your money urgently, will it be available when you want it and without suffering a loss or an early repayment penalty?

And finally, diversification reduces volatility.

These sound like good reasons to diversify. But are they? The problem with diversification is that while it can limit your losses, it can have a far greater limiting effect on your gains. It dumbs down your investment performance to a low average. As DIY investors we can do much better than that. Remember, the worst you can do is lose 100% your money, but on the other hand the share market gives you plenty of opportunities to earn far more than 100%.

Many people lose sight of the fact that the primary objective of a long-term savings plan should not be to reduce volatility or the risk of loss, but rather, to maximise returns.

There is another problem with diversification. It works on the premise that if one asset class is doing poorly this will be offset by others in your portfolio doing well. Unfortunately the opposite is more likely to be the case. In the last 12 months people have lost money from fixed interest debentures in finance companies and a decline in the share market and property prices are widely tipped to take a tumble as well.

So here’s the big question: Is there a way for the average DIY Kiwi investor to deal with diversification and maximise returns? Can you have your cake and eat it too? I believe you can. I’ll explain how in my next blog post.