Saturday, 24 October 2009

Why Invest in Australian Companies?

The views expressed here are for education purposes only.

About 55% of my net worth is in Australian shares, 30% in non-Australian shares, 10% in bonds, and 5% in other assets like cash and one car.

I have heavily weighted my portfolio to Australian shares because I have a lot of faith in the future of the Australian economy. I will list below the arguments for investing in corporate Australia.

High exposure to resource companies
Concerns about government debt and money-printing in developed economies have stoked inflation fears. When people are worried about inflation, they seek refuge in assets like gold, silver, oil, copper, etc. One-third of the companies in the ASX200 index is made up of resource companies. If inflation does explode, rsource companies are able to sell their products for more, increase revenue, and hence increase dividends and stock prices.

Australian companies pay higher dividends
For the price of their stock, Australian companies tend to pay higher dividends than non-Australian companies. Thanks to the imputation credit system introduced by Paul Keating in the '90s, Australian investors are also advantaged because company profits are no longer double-taxed.

Eventually the stock market will rise
Many fund manager talk on and on about how if you hold stocks for the long run you are guaranteed to make a killing. This view has been challenged by Professor Zvi Bodie who claims that holding stocks for the long run is actually more risky than holding stocks for the short term. Professor Bodie's assertions should be taken very seriously. They suggest that most of those who rely on their superannuation (or 401(k) in America) are playing roulette with their retirement money. Let us assume that Professor Bodie is right. Let us also assume the worst-case scenario, which is that the ASX200 follows a random walk. This is in line with the idea that the stock market is a casino (as Keynes said it was) and that holding stocks for the long-term does not reduce risk. Let us also assume that the ASX200 cannot reach zero. I make this assumption because it implies that the entire Australian economy is destroyed and that civilization is no more in this country. While apocalypse in Australia is certain possible, let us assume it cannot happen. Even if we simulate the ASX200 index following a random walk and never reaching zero, eventually there must be a rally, and when this rally happens, it is a good time to sell. In reality, when humans see stock going up, they buy more stock, which pushes stocks up even further, creating an even bigger bubble. This herd mentality should ensure that if a rally does occur, it will be amplified. The difficult part is knowing when to sell, which is similar to the decision of when to walk away from the casino once you have made enough money.

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