Every day when we turn on the TV, radio, or read the newspaper, we are told whether the share market in Australia has increased or decreased. The Australian stock market is often referred to as the ASX 200, which is the 200 largest companies listed on the stock exchange in Australia.
One approach you might take to investing is index investing. The main benefit of this strategy is that you are investing in a wide basket of investments that tracks an index such as the ASX 200. This centres around the notion of diversifying and spreading your risk. It also ensures that you achieve market returns, although these returns may be positive or negative depending on what happens during the course of the year with the respective chosen index.
If you’re a retiree, however, it’s important to consider how appropriate this investment strategy is for you and, in particular, the risks associated with it.
One risk that is often overlooked by retirees is the safety of their income stream. In Australia, just six stocks account for half the dividends paid out in market capitalisation terms. They are:
- Commonwealth Bank
- ANZ Bank
- National Australia Bank
- Westpac Bank
- BHP Billiton
Over the past 12 months, BHP Billiton has slashed its dividend payouts, a classic example of what happens when one of these behemoths suffers losses. Of course, this has a flow on effect on retirees with BHP Billiton in their portfolio, reducing the income they receive to fund their periodical pension payments.
So with the Australian marketplace being so concentrated, it raises the question whether investing in an index such as the ASX 200 can provide you with a sufficient level of diversification.
Consider what might happen if other members of the top six or other banks and resource companies in the ASX 200 reduced their dividend payouts simultaneously. What impact would this have on a retiree’s income stream? If this transpired, it would have a rather large impact on most index-based portfolios.
By contrast if you look at the global market, the top six dividend payers represent less than 20% of global dividends being paid out, so this market is far less concentrated in terms of dividend payouts.
This is not to say you shouldn’t invest in index tracking. For some retirees there is merit in owning this type of investment. But it is important to understand the risks as well as the benefits associated with these types of investments.
Please also remember that before embarking on any investment decision, you should always seek professional guidance from a licensed financial planner. Of course, I recommend AJ Financial Planning.