Peter Lyons: Trading lessons keep pupils invested

The students were made aware they were buying shares in companies that produced goods and provided services. Photo / Dean Purcell

Opinion

It's not rocket science, but there is a dark side - what an economics class learned about the NZ stock exchange.

My students call me "Monotony" Lyons. I am blessed with dulcet tones that can reduce an entire class to slumber. Yet occasionally I manage to engage.

Several years ago I was given the opportunity to introduce a course in financial literacy for my senior students. I had come to the startling realisation that not all students shared my enthusiasm for well-drawn demand and supply curves. Some were doing commerce because they wanted to make money.

The focus of the course was on investing. We established a share fund investing in the New Zealand sharemarket. The students analysed and presented on a variety of shares listed on the local market. They were then required to select, by consensus, 10 stocks for our portfolio.

The discussions were robust because there was skin on the table. Our initial fund was $20,000 contributed by them, myself and several other staff.

The timeframe was four years, and dividends would be reinvested automatically where possible. It would be a buy and hold strategy.

We are now halfway through the investment period and most of the group are at university. Several have developed an interest in studying finance. The gross returns are about 35 per cent. We have learned some interesting lessons about investing in shares in New Zealand.

Lesson one

The New Zealand sharemarket is not designed for small-scale and young investors because the brokerage costs for trading in small amounts are prohibitive. The brokerage firms charge remarkably similar fees, suggesting a cosy relationship between them. This should be a concern for a Government that is trying to encourage Kiwis to diversify their investments away from property. It should also be a concern for the NZX, which should be encouraging our young people to consider owning New Zealand businesses.

Lesson two

Selecting a portfolio of stocks is a rational, logical exercise. The NZX is full of companies with dominant market positions, strong cashflows, good trading histories and strong fundamentals. It is not rocket science.

Lesson three

Although the gross return of this portfolio seems spectacular, the overall market has risen significantly during this period. Much of our return can be attributed to good fortune in riding a bull market. This should provide a note of caution for those with KiwiSaver funds heavily invested in New Zealand shares. As with any investment, there is no guarantee that these returns will continue in the near future. Comparing the performance of investment funds over a short period of one or two years is of limited value.

Lesson four

Shares are not a form of gambling. The main lesson I wanted my students to absorb was that they were buying companies that sell actual goods and services. The aim was to become part-owners of businesses involved in the most profitable areas of our economy.

Lesson five

Having a well-balanced portfolio of investments is as important as the individual shares selected. Proper diversification is essential. There is no such thing as a guru in investing. No one knows the future. Having 10 shares in a portfolio is the minimum, but we were constrained by the funds available. Some shares are likely to turn out to be dogs but their poor returns should be outweighed by the winners.

Lesson six

Investing in shares is volatile as there is always a risk return trade-off. Share prices do not change in a neat linear fashion because of the randomness of events that affect different companies and shares. It is a random walk, but if a portfolio is well-balanced it should be in an upward direction over time.

Lesson seven

It is time in the market rather than timing the market. This is why we decided on a buy and hold strategy for a reasonable period of time. Constantly trading to try to beat the market is very costly in brokerage fees. It also implies that the trader has better insights or information than everyone else in the market. This is unlikely to be true for anyone except inside traders.

Lesson eight

The New Zealand sharemarket is vulnerable to political influences. There are several stocks on the market that are susceptible to the results of this year's election. This may sound like a capitalist bleating about politicians affecting his returns. But we need a better resourced Commerce Commission with sharp teeth to ensure that firms provide a fair deal for consumers. We have a dislike for regulation, but our sharemarket reveals that many firms operate in markets that lack the competitive pressures to ensure a fair deal for consumers. A well-resourced independent watchdog with very sharp teeth would improve the efficiency and fairness of our economy.

Peter Lyons teaches economics at St Peter's College and has written several economics texts.