DAVID KOCH: My golden rules for investing in the share market

The cost of living is biting, high interest rates are hurting borrowers, the economy is slowing to barely a crawl, retrenchments are running hot — and the share market is making new record highs.

WTF? How can that be happening?

Australia’s All Ordinaries Index has smashed through 8000 points to a new record high this week. In America, the Dow Jones Index and the broader S&P500 both jumped to record highs. The S&P500 is up 19.5 per cent since the start of the year and 37 per cent over the last 12 months.

Over the past year, the US market has mainly been driven by the “Magnificent Seven” technology giants because of the perceived benefits of AI — Nvidia, Microsoft, Amazon, Apple, Alphabet (Google), Meta (Facebook and Instagram) and Tesla.

The rest of the companies and sectors have largely been left behind by comparison. Until this week. In just five trading sessions this week the Russel2000 Index of America’s “small” companies rose 12 per cent over just five days.

The Australian share market has been dragged along by this euphoria and your superannuation fund performance will be a big beneficiary.

But is this euphoria justified or is it a bubble ready to burst? Is this as good as it gets? These are the big questions spooking many investment analysts.

The weak economy doesn’t seem to justify the euphoria and the bond markets are signalling that the share market is way overvalued. What makes me nervous is that bond markets were giving similar signals prior to the Global Financial Crisis.

The world’s best investor Warren Buffett has a famous investment mantra that investors should be “fearful when others are greedy, and greedy when others are fearful”. Are we at peak greed?

More than 20 years ago Buffett devised a formula for judging whether the share market is overvalued or not. The so-called “Buffett Indicator” measures the total value (capitalisation) of US shares and divides it by the value (GDP) of the US economy.

The Buffett Indicator is currently at a record high of around 200 per cent. The previous high was November 2021 and the market dropped 25 per cent over the following nine months.

I don’t mean to hose down the share market party. You just need to keep it in perspective, follow it carefully and keep in close contact with your investment adviser or broker.

The best bit of advice I’ve received is from Henry Jennings of the Marcus Today investment newsletter on what to do:

• Nothing yet. Enjoy the ride
• Don’t sell anything until it starts. The best bits are the frothy bits. Don’t miss them by being pious about “value”. This is about exploiting the herd, not assessing value
• Don’t buy anything up here
• Don’t predict the top ahead of time
• When it does start, do something. Make a decision. Even if you’re wrong to sell, your only risk is not making money. I think you can handle that.

It is a really sensible approach. And it’s a good time to brush up on the golden rules of share investing which I’ve put together from talking to share market gurus over the decades.

The share market is really a great mixture of human emotions, hopes, fears, greed, enthusiasm, stupidity and even sometimes wisdom. So, you can see the benefits of having a basic set of principles as a guide

Do your homework before buying

Don’t buy — or sell — on rumour, hunch or impulse. Get hold of broker reports and the company’s last annual report, read the financial media and of course talk to your adviser. Buy shares that fit in with an investment strategy, e.g. for income, growth or both.

Balance the risk and reward factors

If what you read and hear suggests that the share has more chance of falling in price than rising, don’t buy. Look closely at past performance and future prospects. Remember the sleep test. If the worry of your shares falling keeps you awake at night, don’t buy them. Unless you’re a speculator (a gambler), be satisfied with steady progress.

Keep checking after you’ve bought

Investment conditions can change, company management can change, the company’s objectives can change. Review shareholdings at least once every six months in consultation with your broker or adviser.

Exercise patience

Don’t expect to become wealthy overnight. Most shares will need at least a year to show some reasonable appreciation.

Don’t forget shares can bring income and capital appreciation

We often ignore the impact of dividends. Estimate both these factors and relate them to your personal tax situation.

Be alert to trends

In your daily reading, try to put the news through an investment filter. Political, economic, scientific events may have implications for some companies. If you get any ideas, check them out further and talk to your broker. Being ahead of the herd can mean nice profits.

Be prepared for unexpected events

If the event concerns any of your shares, don’t panic. Review the situation promptly before taking any action. For instance, a sudden drop in a share price may well mean an institutional investor has sold a large parcel, and the price may rebound within a day or two.

Don’t try to back every horse in the race

It is far better to hold a smaller portfolio of shares which you know well and are comfortable with than to invest in a larger number of companies in the hope of picking more winners.

Timing can be important

If the share you want is being actively traded, buy at “market price”, which is an order to the broker to get the best price possible. With shares that are beginning to attract interest, you can sometimes save money by waiting for a brief price dip.

Take a loss quickly

Don’t let pride or stubbornness prevent you from accepting a mistake and correcting it. One big profit makes up for a lot of little losses. So keep them small.

Keep an eye on the ex-dividend date.

When a company declares a dividend, all shareholders on the books at that date receive the dividend, and usually the price of the shares will drop by approximately the same amount. Sometimes, the price of the stock will move back up within a day or two. Naturally if you buy on the date it’s announced, you won’t receive the dividend.

Follow the market

Don’t try to beat the trend. In bear markets, be cautious; in a fluctuating market, think twice; in bull markets, take greater risks.

Take profits

It is better to make a little less profit by selling too soon than to take the greater risk of overstaying the market in an overpriced stock.