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Investing In The Stock Exchange

April 3rd, 2008

People who invest in the stock exchange realise that shares can go down as well as up but continue to do so supported by the following beliefs:

• They have to do something with their savings. If they put it in the bank they go backward. Assume the following: Rate - 6%; Inflation - 4%; Tax - 30%. This gives the following:

Capital (say)	$100,000
Interest	$6,000
Deduct Tax	$1,800
	$4,200
Deduct Inflation	$4,000
Real Return	$200	Equal to 0.2%pa

Sticking the money on deposit may be reasonably safe, but is hardly likely to finance a comfortable retirement. Is it any surprise that people look for alternative investments?

• Property - over the long term - is reasonably safe and the capital value keeps pace with inflation. However, properties cannot be sold brick by brick, the transaction costs are high, and, in the short term, prices can go down as well as up. However, finance is readily available for property investments and the tax treatment is good.
• The stock exchange offers investment opportunities where transaction costs are low, over the long term shares keep pace with or beat inflation, through superannuation and dividend imputation laws the tax treatment is good and small parts of ones share portfolio can be sold as cash is needed. It is not surprising that this is the favourite means of investment. However, as we have recently seen there are risks involved. The stock exchange may go up and the shares that you have invested in go down. However, a balanced portfolio and expert advice can reduce this risk to acceptable properties.
• The stock exchange is honestly and competently run with all relevant information made available so that investment decisions can be made relying on the integrity of the market. The events of the last few months have challenged the belief in this integrity.

We have recently seen companies all but destroyed by short selling - that is selling shares you don’t own, spreading rumours about the target company, driving the share price down thus triggering forced sales and enabling the short seller to buy the shares back at a lower price. The stock exchange had introduced disclosure rules on short selling, but these have proved completely inadequate as hedge funds have become more adept at circumventing them.

One of the means widely used has been borrowing shares and selling the borrowed scrip. This is legally not short selling, but has the same intention and result. However, the actions of the people who are custodians of the shares lending these shares to allow the short sellers to drive down the value of these shares is questionable and could expose them to legal action. A successful prosecution would eliminate this practice.

Laws must be introduced to convince people that the market is operating honestly or people will lose confidence in the stock exchange. It will not be easy to frame these laws in today’s global economy, so the penalties for non-conformance must be extremely harsh. The profits from market manipulation are huge, so the penalties must match the possible gains. These laws must also mirror those of our main trading partners so that they can be policed internationally.

Despite the problems highlighted above, the majority of transactions through the stock exchange are genuine and the market operates well. However, it must be improved as the manipulators become increasingly sophisticated. The stock exchange must continue to be seen as a safe investment for hard earned savings. The alternatives do not offer much.

As well as looking at the Stock Exchange as an investment vehicle we must remember its major role in the economy. That of providing capital for new businesses.

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2 Comments »

1. How can we invest in the Stock Exchange when we can’t believe the financial statements they issue. The Australian Stock Exchange is supposed to control it but they make money from the volume of transactions. this seems like a conflict of interests to me.

   Comment by wiseguy — April 15, 2008 @ 12:52 pm

2. The government is taxing us on inflation. I wouldn’t mind if the interest was index linked. no wonder people don’t save in Australia.

   Comment by mimuga — April 15, 2008 @ 1:07 pm

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