Investing is a broad subject with lots of different things to learn.

To help simplify tricky questions and clear away confusion, we’re running an ongoing Q&A series. We hope these little discussions provide you with helpful insights to further your thinking as you progress towards your goals :)

Just so you know, in many cases there’s often not a ‘right’ answer, so be sure to think carefully how to adapt any information to your own circumstances.

If you have a burning question you’d like answered, feel free to leave it in the comments below, or post it on the Pearler Exchange.

In this Q&A session, we’re tackling the following topics:

• Swapping a house for a share portfolio to fund travel
• Why index when other funds perform better?
• Recovering from a bad investing experience
• I’m a new investor, where do I begin?
• Living off dividends using Aussie shares?

Let’s dive in!

“I’m interested in selling my house to travel. Am I crazy?”

Scenario: I bought a home 10 years ago and have focused hard on killing the mortgage, having almost paid it off. The home has increased a lot in value, but I’m not keen to stay there anymore. I’m toying with the idea of selling it, investing the money into shares and then using the income to fund my travels. I also don’t mind renting when I get back and have already figured out this will leave me with some spare cashflow after paying rent. Thoughts?

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First, a warning: if you tell people, they will probably think you’re crazy. The idea in the general public is you must always own a house if possible and you’ll be left poor in old age if you don’t. But we know that’s completely wrong.

Sure, a paid off house is a valuable asset and saves you from paying rent forever. But if you're good with money and have investments, you definitely don’t need to own a house to become wealthy, or even to retire. So I think this is a perfectly reasonable life decision, especially in the happy scenario where a house has gone up a lot in value and is mostly paid off.

Some risks to keep in mind: if you change your mind and want to buy a house again later, it’s possible prices are less affordable. And if you’ve semi-retired, getting a bank loan will be difficult. Also, it’s possible that rents keep growing at a fast rate for another few years, which may cut into your safety margin a bit. That said, you’ll still have a portfolio which can help fund a future house purchase.

“Why index when other funds perform better?”

This one comes up pretty regularly among groups of investors.

It usually starts with a statement around a specific fund returning, say, 15% over the last 10 years, or something to that effect. The logic goes: “clearly I’ve found a long-term investment which is better than average, so surely I should just go with that.”

After all, 10 years is a long time, so why would you invest in something less impressive which lagged over the same period? The more weathered investors know the answer to this, and it goes as follows…

Unfortunately, it’s just not that straightforward. If it was, wouldn't everyone just load up in this one magical fund (or several) that delivers much better than average returns?

The problem is, we’re extrapolating a 10-year period and assuming that’s a permanent feature of this particular investment. And that’s not how these things work. As much as we want it to be true, it doesn’t make logical sense. Because even if there was something ‘special’ about a fund or strategy, the price of those companies will then get bid up to a level where the strategy can no longer deliver outsized returns.

Is it reasonable to expect one fund to return 15% per year in perpetuity if the long-term market average is 8%? Of course not. Expecting to earn double the returns is a wildly over-optimistic assumption in any scenario.

Now, it’s clear that some funds will do better than others, and better than the market, over lots of different timeframes. But over the long run, stats show that almost all will fail to beat the market over 20 years.

We should, in fact, expect most diversified funds to end up having somewhat similar performance. Over time, performance has a funny way of evening itself out. The fancy term for this is called reversion to the mean. Put another way, markets and funds tend to oscillate around a long-term average.

Of course, some fund managers will pick a fantastic bunch of stocks that will beat the market over a 10-year period. And even certain themes and strategies will have their time in the sun. But gravity exists and markets are fairly efficient. So hoping to always have the winning hand is a recipe for disappointment.

Many of us have been through this exercise before. Eventually, we realise it’s simply easier (and more effective) to not play a game that’s so hard to win. Stack the odds in your favour and go with the probabilities. Simplicity, wide diversification, low cost, all the boring stuff that gets the job done.

“After a bad experience with actively managed funds during covid, I’m now looking at index funds, but what’s the risk with them?”

I’m going to take a guess here. The main reason for the bad experience was not actually due to the managed funds. I’d say it was probably due to the market environment at the time.

The covid crash of 2020 saw markets fall significantly over a short period. That’s simply the reality of markets from time to time. We can either stop investing, or we can see it as an opportunity to build our portfolio while prices are lower. Which, by the way, can really speed up the wealth building process, despite being scary at the time.

The truth is, there’s no magic fund that will have great long-term returns while avoiding the downside of markets. That’s just the way it is. The reason many people choose index funds is because it’s so difficult for managers to do better than the market (see previous question) or soften the fall during a downturn.

Index funds switch the risk from stock selection, to plain old market risk. You’re now betting on an entire market rather than a chosen group of stocks. And that bet is tied to the future profitability of Aussie or global businesses as a whole.

This can also give us a bit more certainty. Index funds are regularly updated to account for new companies entering the index, while other dying firms are removed from the portfolio. This automatic updating is very useful as an investor, because you don’t need to know (or care) what the future best companies or industries are going to be. Whatever happens, it’ll be reflected in a market-tracking index fund.

If anything were to happen to the index fund manager, the management of our funds can transfer to another manager (remember, the shares represent a basket of underlying shares owned by us, not the manager).

Also, when we experience a sharp drop in share prices, it doesn’t mean the companies inside the fund are actually collapsing (though company troubles are always occurring somewhere). It’s mostly a reaction of fear and uncertainty that causes steep price declines in a short period. But markets, the economy, and life move on. Eventually, we realise the world isn’t actually ending, and things begin to recover.

“I’m a new investor, where should I begin?”

Oh boy, this can be an awfully tough question to answer. Often, the newbie is fishing for recommendations of what stock or fund to invest in. But as readers will be aware, there’s no one-size-fits-all and, in any case, that would clearly be personal advice.

We usually tackle this by sharing resources that'll point you in the right direction. That way, you can come to your own conclusions and decide for yourself. Because it depends on your goals, your temperament, and other things too, which I can’t answer. I'll share a few resources below, and I hope they don't overwhelm you. Regardless, just take your time getting used to this new world of investing, do what you’re comfortable with, and learn as you go.

Some good places to start are the Shares page , which lists (in order, I believe) the most popular investments in the Pearler community. That gives you a decent list of options to begin investigating.

Also, the following article (which I wrote) has some important questions for a new investor to ask themselves: Newbie Investor Checklist .

“Should I just live off dividends using only Aussie shares?”

Ways to live off a portfolio deserves its own article, so I’ll get onto that soon. But let’s tackle this question now.

There are several methods for creating income from a portfolio. One way is to take a dividend approach, where you simply use annual dividend payments to fund your expenses.

This strategy is much easier done with an Australian-focused portfolio. Due to much higher dividend yields and franking credits, Aussie shares are a natural cashflow producer.

As for whether this approach is right for the individual, again, it depends. I’ll share thoughts from my own situation in a moment, but as with any strategy there are things to consider. These include:

• What if Australian companies lag the world over for the next 30 years and the returns (and dividends) aren't as good as a more diverse portfolio?
• The Aussie index (and especially dividends) is quite concentrated in banking and mining. Problems in either of those industries could hurt dividends for many years given the reliance on a smaller group of companies.
• Tax policy around franking credits could change, making Aussie shares less attractive. Companies may choose to pay out less and reinvest more or buy back shares like US companies do. This could result in lower dividends, plus diminished franking credits, possibly forcing the investor to switch strategies later.
• Global companies (mostly US) have lower payouts, but dividends grow faster as a result. This helps dividends continue to outpace inflation. Relying on high payouts from the ASX means lower growth and possibly long periods where dividends lag behind inflation.

There are other things we could mention, but those are the main ones. How you answer those questions to yourself will dictate whether the approach makes sense to you. For years, my focus was to live solely off Aussie dividends. But over time I have modified my stance on that.

Why? Well, I came to appreciate the importance and usefulness of having more diversification. In addition, I overcame my aversion to the idea of selling some shares to create extra income, which I wrote about in-depth here. That said, my portfolio is still Aussie-heavy as I continue to steadily diversify.

Look, some people are fanatical about having a perfectly diversified global portfolio, and you’ll be scorned for considering anything else at all. Other folks aren't really that bothered even after thinking about some of the risks. It's a spectrum, really, and I sit somewhere in between, appreciating the psychology, merit, and practicality of both.

At the end of the day, if someone is happy with their strategy after considering the ins and outs, then that’s what counts. The best strategy is the one you can stick with.

Final thoughts

I hope you enjoyed this Q&A session, and these answers gave you food for thought.

Remember, if you have a question on a topic you’d like some more information on, feel free to post it on the Pearler Exchange. They’ll be answered by fellow investors in the community – like myself, someone more knowledgeable, or one of the Pearler team.

You can also post a question down in the comments selection and we’ll cover it in a future Q&A article.

Until next time, happy long-term investing!

Dave