Investing in 2021: Share trading, exchange traded funds and economic recovery

What to expect from the share market in 2021.

Compared to other nations, Australia has fared relatively well through the pandemic. With the Australian economy open for business again, and the prospect of a successful vaccine emerging, economic growth is inciting hope and creating opportunities for consumers to build their wealth.

Households have accumulated an extra $113 billion in savings over the course of 2020 according to the Australian Prudential Regulation Authority, and in June the household savings rate peaked at 22%, thanks to government stimulus measures and lockdowns minimising discretionary spending. But with interest rates at a record low, savings accounts have become less attractive for Australians to stockpile their wealth. Instead, households are increasingly looking to shares for higher relative gains.

The pandemic made Australians more share-friendly

Compared to other nations, Australians are quite conservative when it comes to investing their money. In November, a Finder survey found just over one in four Australians (27%) invest in shares. This may seem significant, but this figure is actually modest when compared against other countries: in the US, 35% of Americans own stocks outside of their retirement fund, while 33% of Brits own shares.

However, COVID-19 may have been a push in the right direction for some, with a Finder survey revealing 13% of Australians started investing in shares during the pandemic. With interest rates forecast to remain low for some time, more Australians would be doing themselves a favour by looking beyond cash.

Share markets will remain volatile

The stock market proved unpredictable in 2020, and if there's one thing investors should keep in mind in 2021, it is to expect the unexpected. Between February and March the ASX plunged by 33%, reaching its lowest trough since 2016. In theory, a crash provides a golden opportunity to enter the market and buy undervalued stocks. But the beginning of the recession – combined with the uncertainty of the pandemic – sparked investor fear, and many scrambled to sell their shares as quickly as possible.

Research from Fidelity Investments shows one in five investors (26%) sold all of their stocks between February and May, and nearly a third of investors over the age of 65 (31%) sold all their stocks. While the data is based on American investors, there is no reason to believe Australian investors behaved differently.

However, some sectors have fared better than others in the past year. The pandemic has prompted remarkable growth in the technology sector, from education technology and telehealth to ecommerce platforms and digital payment methods.

As an indicator of the exponential growth of the technology sector in 2020, the Perpetual Global Innovation Share Fund, which invests in disruptive stocks, saw 56% year-on-year growth in December. However, as economic recovery looms, Finder predicts growth in technology stocks may slow as investors turn to the banking, energy and travel sectors.

The COVID-19 vaccine will be a major stock market driver this year

While the stock market is steadily returning to its pre-COVID growth trajectory, global recovery hinges somewhat on the success of upcoming vaccine rollouts. The reduction of restrictions and resumption of international travel is expected to reignite the economy beyond the technology sector, but the assumption that the vaccine will be the magic pill for the global recession is naive.

According to Russell Investments' Composite Contrarian Indicator, investor optimism is nearing pre-pandemic levels, which makes markets particularly vulnerable to bad news. With ongoing uncertainty around COVID-19 and global politics, share markets are likely to remain volatile in the short term.

Nevertheless, near-zero interest rates make the share market one of the best investment options for 2021. For the more risk-averse, indexed exchange-traded funds (ETFs) are diversified funds that follow the same growth trajectory as the index it tracks (for example, ASX 200). In general, these sector-neutral ETFs are less risky because they give investors a buffer when one area of the economy suffers.

Putting all your eggs in one basket is a risky game

In contrast to indexed funds, which tend to perform at the same rate as its index, the figure below shows just how risky it can be to bet on a single stock, even when a company is performing well. The chart shows the five-year growth of five of the top performing stocks of 2015. Of these stocks, two have seen tremendous growth over the past five years (Northern Star and Evolution Mining), one has seen strong growth (Domino's Pizza), and two have declined (Blackmores and Mayne Pharma Group).

Those who had invested in either of the mining and resources companies five years ago would have fared well: a $1,000 investment in Northern Star Resources in 2015 would have grown to $3,760 by now. In contrast, the same investment in Mayne Pharma Group would have left you with just $250. The analysis emphasises the importance of asset diversification for long-term returns, and just how tricky it can be to predict the "winners" ahead of time.

Final thoughts

With the cash rate expected to remain unchanged for the next few years, the best places to keep your money depend on your goals and appetite for risk. The share market remains a reliable long-term investment when assets are appropriately diversified, but investors should expect price volatility to continue in the short-term. The low and steady cash rate also makes now the ideal time to pay off any remaining debts.

Overall, financial advisers agree that trying to "beat the market" is not a sustainable strategy, especially for inexperienced investors. Understand your financial goals and timelines and invest accordingly. And if you're a young investor in it for the long haul, don't let one economic recession break your sweat, there will be plenty more where that came from.

Finder's Insights Blog examines issues affecting the Australian consumer. It appears regularly on finder.com.au.

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