Think you can beat the market? Hear this cautionary tale

Property or shares? That is the never-ending question. The older I get, the more I prefer shares, and recently I wrote about an investment unit I bought for $220,000 in 2003, which I’m about to sell for $550,000.

It sounds a good deal on the face of it, but when I ran the numbers through the stock market calculator on my website, I discovered that if I had invested $220,000 in the All Ordinaries Accumulation Index 20 years ago, I would now have $1.23 million.

Time and time again, people have told me they want to invest in shares. My response has always been to invest in an index fund.Credit: Wayne Taylor

That’s a compound gain of 9 per cent per annum – and there’s more. Instead of getting a taxable income of $500 a week rent – less outgoings such as body corporate fees, rates, insurance, and land tax – that $1.23 million in an index fund would be returning $55,530 a year, or $1063 a week. The cream on the cake would be that the income would be almost tax-free, thanks to franking.

One reader gave me a dressing down. He claimed that he put $300,000 into a portfolio just before the global financial crisis and lost a third of his capital. Fifteen years later, the portfolio still hasn’t recovered. I pointed out to him that according to my stock market calculator, his portfolio would now be worth $738,000 if the money had been invested in a fund that matched the All Ordinaries Accumulation Index, and assuming all dividends are reinvested.

This made him even more unhappy. He told me it’s impossible to invest in a product that matches the All Ordinaries Accumulation Index because such an animal does not exist – and furthermore, that I was gilding the lily by even mentioning the Index. He claimed that it would be far more ethical to select stocks such as AMP, BHP or Telstra.

This information is wrong in so many ways, but it’s worth a discussion for anybody thinking of investing in shares. It’s true that no investment matches the All Ordinaries Index exactly. Why would you want to? It contains about 2000 companies and 85 per cent of them could be described as businesses with no cash and no hope. Many of them are speculative mining companies.

But the essence of the index is the top 300 companies, which make up 85 per cent of the total value and produce 97 per cent of the profits and dividends. And there most definitely are products that track the top 300 companies, such as the Vanguard Australian Share Fund (ASX.VAS).

This fund started on June 30, 1997, and Vanguard told me if $100,000 had been invested when the fund started, and all dividends were reinvested, the portfolio would now be worth $732,412. That’s a total return of 632.4 per cent after management fees and transaction costs.

The calculator on my website is an educational tool, which shows monthly values from January 1, 1980, when the concept of the All Ordinaries was formed. It enables people who are considering investing in shares to run “what if” scenarios. You can enter a notional investment sum and a notional finishing and starting date to see how an investment would have performed if it matched the Index.

To check the validity of my calculator, I ran the Vanguard numbers through it. The answer was $775,000, a compound gain of 675 per cent. The difference between the two is insignificant. The reason I never use specific shares when I’m talking about performance is that requires a degree of skill in picking winners, which the average person does not possess.

The main risk with picking individual stocks is buying duds. That is always a risk with individual companies – even household names, including so-called ‘blue chip’ companies like ANZ, Qantas, Myer, etc.

But the chances of the entire market covered by broad index funds going bankrupt is almost zero. Broad index funds have beaten the vast majority of professional fund managers the vast majority of the time.

Time and time again people have told me they want to invest in shares, but they don’t know where to start, as they wouldn’t have a clue about picking stocks.

My response has always been to invest in an index fund: there are no decisions to make; it pays around 4.5 per cent annually, which is mainly franked; it cannot go broke; and over the last 120 years it has averaged around 9 per cent per annum. That’s good enough for me.

Noel Whittaker is the co-author of Downsizing Made Simple with fellow finance expert Rachel Lane, available here. Email: [e-mail]

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

Expert tips on how to save, invest and make the most of your money delivered to your inbox every Sunday. Sign up for our Real Money newsletter.