When you buy shares in a company, you are buying a part of that company. This means you share in the company’s performance in the form of profits which can be given to you as dividends and/or capital growth through the value of your shares increasing.
The company you are investing in benefits by using your money and that of other investors to finance its business or its expansion, without having to borrow money.
Shares outperform other investments over the longer term
Although past performance is no indication of future performance, history suggests that Australian listed shares have outperformed other types of investment over the longer term.
Tax benefits from shares
Where companies have already paid tax on their profits, tax credits known as franking credits may be attached to the dividends the company pays to you. These franking credits can be used to offset tax payable by you on other income. In addition, shares held for more than 12 months qualify for a 50% discount on any capital gains tax payable.
Share Dividends and Dividend Imputation
Dividends from Australian companies are distributed to investors after companies have paid tax on their profits. Under the dividend imputation system (which prevents double taxation of company profits), investors receive a credit for the amount of tax that their company has paid on the original profits. The system works as follows:
If a company makes a fully taxable profit of $1000, it pays tax at the current company tax rate of say 30%. Thus it pays $300 in tax and has $700 left to distribute. If there are ten shareholders, each receives an after-tax dividend of $70, with a tax (franking) credit.
Since the profits associated with the dividends have been fully taxed, the after tax dividends are said to be fully franked. However, there are situations which will not be detailed here when this is not the case, and dividends can have partial or no franking.
For after-tax dividends, the grossed-up amount (that is the shareholder’s share of the pre tax profit) must be included in the shareholder’s tax return as assessable income. In this example, the grossed-up dividend amount is $100 ($70 plus $30 company tax paid with respect to that dividend). However, a tax credit of $30 is also given.
The effect of the credit is that, if the shareholder’s marginal tax rate is less than or equal to 30%, no tax will be paid on the dividends.
If the shareholder’s marginal tax rate is above 30%, then tax must be paid. For example, where the marginal tax rate is 48.5% (highest marginal tax rate including the Medicare Levy):
Assessable income = $100 (i.e. $70 + $30)
Tax payable = $100 * 48.5% = $48.50
Tax credit = $30
Effective tax payable = $48.50 - $30 = $18.50
So, the effective tax rate on the dividend is: $18.50/$70 = 26% (which is significantly less than 48.5%)
Thus, dividend imputation can enable an individual, who invests in a company that pays tax, to reduce the tax paid on his or her income. This applies whether this investment is made directly or through a unit trust or master fund. For example, a retiree on a marginal tax rate of 18.5% (including Medicare Levy) can receive dividends with no tax liability and can use franking credits to offset tax payable on other income, e.g. Interest income. An example follows:
The retired person receives $70 as a dividend with a credit of $30. Total tax payable is $17 (17% of $100) but franking credits of $30 reduce this tax to zero leaving an excess franking credit of $13 ($30 – $17).
If $100 income from a fixed interest investment is also received, the $17 tax liability on this amount is reduced to $4 by using the $13 credit.
Diversification in shares
Many people know the saying “don’t put all your eggs in one basket”. The Australian sharemarket helps you to do this by offering a wide choice of companies in which to invest. There are over 1700 companies listed on ASX. These companies are involved in a wide range of industries covering most sectors of the economy including financial services, industrials and healthcare. By investing in a range of companies you can spread your risk.
Flexibility in shares
You can buy and sell shares quickly. You can sell shares and generally have access to your money in no more than three days. Other investments often take longer to sell and get your money back. This concept is known as liquidity. Remember some shares can be traded quicker than others due to their increased liquidity. (Liquid investments have the benefit of greater flexibility).
Control over your financial future
You can decide exactly how your money is invested, enabling you to have a lot of control over your finances. You can of course choose to share this responsibility with your financial adviser or a stock broker who can advise you on what shares to buy and sell.
What does it cost?
Trading shares has become much cheaper in recent years as stock brokers have made use of new technology to provide a better service to you. Buying and selling shares online can cost as little as $30 for a transaction-only service. You may need to pay more if you want advice and/or access to any research on a company.
What risks are there in shares?
Although the sharemarket historically has outperformed other investments over the long term, the market can experience volatility in the short term. Individual stock prices can go down as well as up. It is important to monitor your shares’ performance, and to regularly re-evaluate whether they continue to be a good investment for you.
Other ASX Traded Instruments
A derivative is a financial investment derived from the value of another financial investment and is also traded on the ASX. They can also be used as a risk management tool when investing, to expose the investor to more or less of a risk. Depending on how they are used, derivatives can help investors protect the value of their securities and investments and be used to provide the investor with additional income. There are several types of derivatives that include the following;
A contract between two parties conveying the right, but not obligation, to buy securities at a pre-determined price, on or before a pre-determined day.
Trading and Investment Warrants
A warrant is a financial instrument issued by a bank or financial institution and traded on the equities market of the ASX. There are a variety of warrants available that give investors the flexibility to meet the demands of the market.
Involve trading in identical contracts for delivery of a commodity at a future date.
Warning: Trading in derivatives should only be undertaken by investors who are committed to investing for the longer term and who have sufficient surplus cash flow to meet their commitments and interest repayments particularly where borrowed funds are used.