“How do I get started in the share market?”

This is the question regularly proposed at seminars and online. While most investors are well on their way, an examination of investing from first principles under current market conditions is a useful exercise for even the most experienced investor.

You can only trade your own view

The first step that investors must take is ownership of their activities. It’s always wise to gather information and seek the counsel of experts. However, no matter who or what investors consult, ultimately the responsibility for the performance of the investments rests with the individual. After all, it’s your money. Investors seeking control of their financial destiny must accept this responsibility – the benefits of good investment and the blame for poor decisions.

Asset allocation

Next step is to determine how to spread investments across asset classes. Choices here are a function of both the current market and individual preferences and characteristics. Those nearing retirement might rate capital stability highly, and allocate a significant proportion of their investments towards cash and bonds. On the other hand, investors with longer time frames may take on more risk, seeking higher long term returns. This group may allocate more towards shares and property.

A simple measure of whether your investments suit your risk appetite is the “sleep at night” factor. If your market risk is keeping you awake, it’s time to dial back the risk.

Investment principles

Here’s where the principles kick in. Investors just starting out generally have longer timeframes. This is important because the power of compounding returns rewards time in the market. As long as investors are receiving returns (capital and income) and avoiding wipe outs, there is a path to long term wealth. Asset allocation is just one example of diversification, the key risk management factor for investors.

Diversification within asset classes is also important. A challenge for newer investors is a lower capital base, making it more difficult to buy all of the stocks an investor may favour.  A strategic approach is to start by accumulating a core portfolio of high quality stocks, with a view to increasing the number of stocks and the risk profile as the capital base grows.

The three stock portfolio

Taking this approach, investors can start their portfolio with just three stocks :

ANZ, BHP and Wesfarmers

ANZ – one of the big four banks, with an extensive Australian and Asia Pacific presence and representation around the globe. It has a strong business in its home state of Victoria, is the up and comer in retail banking, and is targeting its Asian operations to produce 30% of its income. At current prices, it’s more than 20% below its 2015 high, and has a dividend yield around 9% with franking.  Importantly, it is a good representative of the financial sector, which now accounts for 47% of the main Australian share market index.

BHP – is the world’s largest listed mining stock.  It’s “four pillars” commodity strategy (possibly extended to five at some stage) combined with operations all around the globe give it a diversified, blue chip, metals and energy exposure . It’s trading at a 30% discount to its 2014 high, at less than half its peak price. It’s also a good proxy for the materials and energy sectors, which combined comprise around 20 % of the index.

Wesfarmers (WES) – a true conglomerate, WES exposures are weighted to retail through its ownership of Coles, Kmart and Bunnings. Additionally, WES has industrial, energy, chemical and property investments. Its portfolio of businesses rounds out the portfolio. Currently trading around a 15% discount to its 2015 high, it is a “defensive” investment compared to the growth orientation of ANZ and BHP.

These three stocks combined offer a diversified exposure that will broadly track the Australia 200 index. It is reasonably balanced between growth and income. Assuming an equal value investment in the three stocks, it has a portfolio dividend yield above 6% once franking is taken into account. As the core of a growing portfolio, it’s an excellent place to start.