December 19, 2023

Equity strategies to build your wealth

No matter what kind of investor you are there are equity strategies that may enhance your investment portfolio

Equity strategies

New investors often turn to the share market to start accumulating wealth. It is easy to access, offers plenty of liquidity and could provide reasonable returns. However, there are equity strategies that some investors can consider to help accumulate wealth.

Let’s start with some statistics. According to the August 2023 Dow Jones S&P/ASX 200 Index Fact Sheet, in the past 10 years the index had an annualised total return of 7.9%. This means investors would have doubled their invested capital by simply following the index and without picking any stocks. And it’s not just the Australian market. History shows that since 1800, global equity market’s inflation adjusted return averaged 6.88%1.

Are you a passive or active investor?

This level of return, together with the ease of access more than justified the rise of ‘passive investing, that is investing in an index and holding for a long time. It also minimizes the cost of research and transacting and reduces the risk of over-concentration – all of which erode returns. The rise in popularity of ETFs (Exchange Traded Funds) illustrates the popularity of this style.

Why then would investors want to consider ‘active investing’, that is, actively picking individual opportunities and adjusting portfolio allocations?  The simple reason is the opportunity to do better by selecting stocks and sectors that have the potential for outperformance, or have, in the investors opinion, been oversold and offer the potential for good returns from recovery.

As passive investing seeks to track an index, there is little opportunity to outperform an index. Passive investing also does not provide for differentiated screening of certain strategies, like ethical investing.

An option is to combine active and passive strategies. For example, this may entail having an 80% exposure to passive investing while retaining 20% to make more tactical decisions to seek high returns, but without putting all your capital at risk if the market and individual stocks move differently to your expectations. The level of active investing can be adjusted depending on your level of confidence in stock selection.

Growth stocks 

Investors aiming to outperform the market would usually consider investing in companies with potential for an accelerated growth rate. The products or services on offer are typically new and innovative, and we are seeing a lot of activity in this space currently as investors seek to pick the winners from the emergence of Artificial Intelligence (AI).

Growth stocks often do not payout dividends because their profits, if any, need to be reinvested for growth or acquisitions. Because of high expectations for growth, the share price can reflect a high valuation. The flip side though is there is often high volatility associated with these stocks, as any setbacks can quickly lower market valuations.

Value Investing

Compared to growth, ‘value investing’ refers to investing in companies that are undervalued, that is, trading below their book value or fair value estimation based on future cash flow. This can happen for various reasons, for example, the business is going through a period of distress and the market becomes overly concerned and underestimates the resilience of the business. Value investors look for these mispriced opportunities, and generally hold them for mid to long term for a turnaround in price. The risk though is that the estimation of fair value is not always easy, and fair value may or may not be realised. Therefore, a considerable amount of effort is required for due diligence and research.

If you are still building your skills for stock selection or are just short of time, there are still options for those seeking to have an active component in their portfolio.

ETFs seek to fill the gap

‘Active ETFs’ are on the rise, and investors can choose a growth, value, or a blend ETF, which is a combination of growth and value strategies. Active ETFs are also underpinning theme-based investing as many funds are now launching ETFs with underlying companies that qualify for a popular thematic or satisfy certain criterion, like sustainable investing or robotics & AI themes.

Income strategy

Another strategy active investors can leverage is an ‘income strategy’. Income from dividends or special distributions is an important part of total returns. In the 10 years to August 2023 the total annual return from the ASX 200 was 7.9%. However, the overall return from increased share prices was only 3.59%, with the rest from dividend distributions. Companies pay dividends at different times during a year, so investors can rotate between those companies to achieve annualised dividend yield higher than the benchmark. This strategy carries high transaction and administration costs.

Don’t try to time the market

The fact that markets are volatile means they move up and down. Even expert investors tend to avoid trying to pick the bottom or peaks of market cycles. By staying in cash and waiting, you may miss the initial rise when markets turn. Likewise, waiting for that little bit more profit may result with being locked in a stock and waiting out the downturn, or selling into a rapidly falling market and potentially taking a loss.

Dollar cost averaging

Instead of entering the market at a single point in time, investors often seek to periodically invest smaller amounts of money into a portfolio of shares across the economic cycle to average out their entry price. Typically, investors apply a disciplined long term strategy that seeks to build positions in companies with a proven track record of growth and performance, while avoiding trying to time the market based on prevailing market sentiment. This strategy may also utilise index-tracking ETFs to achieve the same goal while avoiding stock picking.

Conclusion

The world’s share markets are a global engine for wealth creation, and for bringing new concepts, innovation, and growth strategies to life for corporates.

The most seasoned investor is still on a learning curve when it comes to understanding how markets react to events. While there may always be more to learn, even a new investor has options available to get them started, with opportunities to utilise more advanced equity strategies as their knowledge grows.

 

Important Information

1 The Rate of Return on Everything (Harvard)

The information contained in this article is gathered from multiple sources believed to be reliable as of the end of December 2023 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, we recommend that you consider whether it is appropriate for your circumstances and that you seek independent legal, financial and taxation advice before acting on any of this information. ©2023 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686. 

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