Building an Australian Share Portfolio

For investors who are just starting out on their investment journey, the local share market is often seen as a good starting point. In fact, while Australia makes up just over 2% of the global share market, most Australian investors are heavily biased towards their home market. In almost every global market, investors tend to hold a home bias.

In Australia, there are many reasons why this is the case – a preference for familiar local brand names and businesses, the tax treatment of dividends and an aversion to the currency risk which can arise from investing in overseas markets.

The performance of the Australian share market in the last few decades is also a key reason for the investor home bias. The Australian economy had experienced 27 years without recession in January of 2020, the share market set a new record, with the S&P/ASX 200 breaking through the 7,000 mark for the very first time. Then COVID-19 entered the scene and placed the economy under significant pressure. Well diversified portfolios performed much better than a portfolio of say energy stocks as the oil price hit historic lows.

Getting started with trading

When buying and selling shares, you will need to trade with a broker. This could be a full-service advisory broker who recommends individual stocks to buy, or a lower cost online broker such as Bell Direct where you decide which stocks to buy.

You may choose to purchase shares in individual companies you have selected yourself, such as Commonwealth Bank (ASX:CBA), BHP (ASX:BHP), Telstra (ASX:TLS) and Woolworths (ASX:WOW). Alternatively, you can also invest in a ready-made portfolio through Exchange Traded Funds (ETFs), which provide access to an entire index (i.e. the ASX200).

Before making any investment decision, it is important to consider your individual investment goals and timeframe (covered in part one of this series).

For example, if you are a young investor who is primarily seeking capital growth and prepared to take on some risk to achieve it, you will likely purchase very different assets to a retiree who is seeking regular income and capital stability from their portfolio.

However, before trading on the Australian share market, it’s important to understand its unique characteristics.

The local taxation environment

One of the key benefits of investing in Australian shares is franking credits.

Franking credits are a type of tax credit designed to prevent ‘double taxation’. The Australian Taxation Office (ATO) recognises that corporate tax has already been paid on a company’s profits, which are distributed to investors as dividends.

Once the company tax has been paid, dividends are franked (stamped). Shareholders then get a tax credit for the tax the company has already paid in Australia.

Franking credits are attractive to many investors because if the franked dividends are higher than their marginal tax rate, this could result in a tax refund at the end of the financial year.

For investors at the start of their investing journey with a long timeframe, an effective way to create wealth is to automatically reinvest your dividends, instead of receiving the cash payment – this, which is called a dividend reinvestment plan (DRP), can be easily set up via the registry of the investment (such as Computershare or Link Services). Under the plan, any dividends paid are used to buy additional units in the company or ETF, overall increasing your stake in the particular investment and ultimately supercharging the power of compound interest.

Lack of sector diversification

There are, however, some downsides to focusing a portfolio solely on Australian equities. One of these is that the local market is heavily weighted towards a very narrow set of industries.

For example, the S&P/ASX 200, which is made up of Australia’s largest 200 companies, financials account for around 28% while the materials/ resources sector is 20%. That’s almost half the index in just two sectors.

If you are looking to create diversified portfolio, you may therefore wish to look offshore to tap into global opportunities. This can help to provide both sector and geographic diversification, helping you to spread investment risk. We will investigate this area further in part four of this series.

Sector summary

Three ways to build an Australian Equity portfolio

1. Buy the market with an ETF

In part two of this series, IOZ (ASX:IOZ) was previously mentioned – IOZ is an ETF which invests in the largest 200 stocks on the ASX. A similar ETF to IOZ is VAS, however VAS holds the largest 300 stocks on the ASX. Both these ETFs have a management fee that needs to be paid each year. Both ETFs are managed by large US investment management firms – iShares and Vanguard.

2. Buy the 10 largest stocks on the ASX

As a first step in buying individual shares, you should consider brands that you are familiar with or that you have researched. Many investors simply buy the 10 largest stocks on the ASX. The 10 largest stocks will provide a portfolio that represents around 45% of the total value of all companies on the ASX however no management fee is payable because investors hold and own the stocks directly (rather than through a U.S. based investment company).

In August of 2020 the 10 largest stocks on the ASX were:

Many investors start with purchasing a large percentage of the market with just 10 stocks then add other companies or sectors as opportunities arise over time.

3. Use Bell Direct’s Strategy Builder

Bell Direct has a Strategy Builder tool to help you construct a simple yet sophisticated Australian equity portfolio. To use the tool – Log into your Bell Direct trading account; Select ‘Research & tools’; Select ‘Strategy Builder’.

You can construct your own strategy or select from a menu of existing strategies. For example, during COVID-19 lockdown many investors believed there would be a strain on company cashflows which can hinder a company’s ability to pay its debts. To find companies with low debt through the Strategy Builder, you can simply select the ‘Featured Screens’ strategy titled ‘Profitable and undervalued companies with manageable debt’.

This strategy sets out to discover companies that are enjoying profits and being well managed from a debt perspective, with a stock price that is considered low. We will use this screen to identify stocks that exhibit these important criteria – with future price appreciation in mind.

With a click of a button in October of 2020, the Strategy Builder has applied seven screens to all companies listed on the ASX including revenue, earnings, debt and current price. 17 stocks were identified, and the top ten results are listed below:

The performance of the above portfolio compared to the S&P/ASX200 is:

A link to a short training session on using the Strategy Builder can be accessed here.

Summary

The Australian share market has delivered excellent returns for investors over the past 10 years, and there are many good reasons to consider an investment in our local stock exchange. Even after periods of severe volatility, like the global financial crisis (GFC) or COVID-19 pandemic, history shows the Australian share market is resilient and does bounce back.

However, before investing it is important to consider your individual goals and the diversification benefits that can come from balancing local and global investments.

In the next instalment we will show you how to build an international equity portfolio.

Top three take outs

The Australian sharemarket is like no other – not only is our dividend system unique, but so too is our sector makeup

Getting access to the sharemarket is easy, with three ways to build an Aussie equity portfolio outlined

Consider the benefits of a dividend reinvestment plan (DRP) as part of your wealth creation strategy

Important Disclaimer- This information is for educational purposes only and is of a general nature. It has been prepared without consideration of your specific financial situation, particular needs and investment objectives. This information does not constitute financial advice and you should consider your own financial circumstances in assessing the appropriateness of this information.