Investing in Shares for Absolute Beginners
Stock investing for dummies
A lot of people have realized that investing in shares provides a long-term solution to building wealth. Indeed, with the ease of access to technology and information, there has been a proliferation of individuals worldwide who have taken the bull by the horns and invested directly in the stock market.
When it comes to investing in shares for absolute beginners, however, their initial attraction is often based on a hot tip or because their friends were talking up the huge amount of money they could make from the stock market. Unfortunately, the outcome for many of those who have invested this way has been one of disappointment because they either lost some or all of their capital given that they did not have the right tools to ensure their longevity in the share market.
But before you start investing in shares, you should educate yourself with some simple rules, which is the focus of this article.
What is a share and how do I buy one?
In its simplest form, a share represents ownership in a company.
Companies like National Australia Bank, BHP, Facebook and McDonald’s are listed on an exchange, which is more commonly known as the stock market where shares are bought and sold. In Australia it is called the Australian Securities Exchange while in the US it is referred to as the New York Stock Exchange.
The best way to understand how the stock market works is to look at it like an auction, where there are bidders, a seller, and an auctioneer facilitating the transaction. The ASX is the auctioneer. So if you have 5,000 people wanting to buy shares and 5,000 wanting to sell the same shares, the auctioneer will match the buyers and sellers to exchange the shares at a specified price.
When looking to invest in a company, you are looking for stocks that are likely to rise over the medium to long term. And while there are more than 2,000 companies listed on the ASX, when starting out you should concentrate on investing in quality stocks that are highly liquid until you have gained sufficient knowledge and experience. This means you would be investing in shares from the top 20 to top 50 on the ASX or other any leading exchange.
I can confidently say when you combine this approach with my four golden rules to investing in shares, you will find you have a winning formula for generating strong returns in the stock market.
When buying and selling shares, you will also need to use a third party known as broker who is licensed by the ASX to facilitate the transaction on your behalf. A broker will also assist you in opening a brokerage account so you can buy and sell shares. Depending on your comfort level, you can use a discount broker, who simply executes any trades you place in the market, or you may decide to use a full service advisory broker who will provide you with advice or recommendations to invest in the stock market.
The brokerage costs and terms and conditions will vary depending on the broker you use with prices ranging from as low as $9.95 for an execution broker up to 1 percent or more for an advice broker.
How do I make money from investing in shares?
When investing in the stock market, you can make money in one of two ways:
- If the share price increases, you will have made a capital gain if you sell the stock at a higher price. That said, it is important to remember if the share price falls from your initial purchase price you will lose money if you sell your shares.
- In some cases, you can also receive a share of the company’s profits in the form of a dividend, which is usually paid twice a year, although this will vary depending on each company. Bear in mind, not all companies pay a dividend but those that do see it as a way of rewarding their shareholders.
Isn't my money safer in cash?
While investing in a term deposit is lower risk, they’re often not the best investment option, particularly when the dividends you receive from investing in shares can be around double the rate you receive on your savings. And if you consider the potential capital gains you will achieve if you pick your stocks correctly, you can see why investing in stocks is a better option.
According to the 2018 Russell Investments/ASX Long Term Investing Report, the average yearly return before tax on cash investments compared to shares over the 20 years to 31 December 2017 was:
- Cash Investments: 4.6 percent
- Australian Shares: 8.8 percent.
While these figures are past returns and are not a guarantee of what may occur in the future, it does give you some idea of how shares and cash investments have performed over the long term.
Taking your first steps
Before you start trading in the stock market, it is important to understand why you are investing and what you expect to get out of it, as this will help you to work out your strategy and potentially avoid any irrational decisions down the track.
Therefore, all beginner investors need to ask themselves a few key questions, such as:
- How long do I want to put money in the stock market for?
- How much am I going to invest?
- How many individual stocks do I want to hold?
- What is my tolerance to risk?
- How will I teach myself to invest?
It is important for anyone investing in shares to take the time to gain some knowledge and expertise before taking the plunge, otherwise, you run the risk of being someone who continually takes tips, but doesn’t know how to interpret the information.
The sooner you start to gain the knowledge and confidence in how to invest, the quicker you will get to a point where you will become independent. As a way of starting out, you may want to take a look at Warren Buffett’s approach to investing in shares.
It is also important to learn the basics about how the stock market works, which you can find in the investing education section on your local exchange. If you are in Australia, refer to the ASX Education Centre, while in the US you can refer to the US Securities and Exchange Commissions Investor website.
How much do you need to start?
While there is no definitive answer as to how much you need, you can start investing in shares from as little as a $1,000, although you will need to start a savings plan so you can build up the number of shares you buy.
An important consideration when deciding how much you need to start investing in shares is the brokerage fee you will pay on each transaction. For example, if you purchase shares worth $1,000 and you pay $20 in brokerage to buy and sell, the stock needs to rise by 4 percent or $40 for you to break even.
Understanding the costs involved should help you decide how much you want to invest in each stock.
Choosing which shares to buy
I always recommend the 50 largest companies on the ASX. This is because they typically represent the least amount of risk as they are highly liquid, well established businesses with a history of delivering steady returns, which is why they are known as ‘blue chip’ shares.
When selecting which stocks to invest in, I always recommend basing your decision on both a technical and fundamental perspective. While many have a preference for using one form of analysis over the other, I use both as I find it narrows down the selection of stocks to a very manageable level. I outline these simple but powerful strategies in my latest award winning book, Accelerate Your Wealth - It’s Your Money, Your Choice.
Once you gain the knowledge and experience to consistently profit over time, you can expand your reach out to the top 150 shares on the exchange.
Cheap doesn't always mean a good deal
While some of you may be attracted to stocks outside the top 150, I highly recommended that you steer clear of buying penny dreadful stocks or small cap stocks because while they may look cheap at 10 to 20 cents a share, a small company with a shaky track record can wipe out all of the gains you have achieved on your portfolio as a whole.
Further, just because you can buy 5,000 shares at $0.20 each with your $1,000, doesn’t mean this is better value than purchasing 15 to 20 shares on a stock priced at $60. What matters when it comes to making money in the stock market is not how many shares you own, it’s how much each share increases in value over time.
I would also caution you against buying shares just because the stock price is falling. A company may have announced a profit downgrade or a change in its situation that materially damages its future chances of making money, which is causing its share price to fall.
Before buying or selling a stock, I highly recommend you look at a price chart to gain an appreciation of the historical performance of the stock. If the share price has been falling over the long-term, the company would most likely be considered a high risk investment. Most brokers provide you with basic price charts on which you can view the history of a stock.
How much are you willing to risk?
Before you invest in shares, it is critical that you consider how you are going to manage your risk. In other words, how much are you willing to risk if the share price moves in the opposite direction to what you are expecting? The reason for this is that a lot of people know how to buy shares but very few know how to sell or when is the best time to sell.
To ensure you grow your stock investments and protect your bank account each time you invest in a stock, it is important that you set a percentage stop loss of 10 to 15 percent depending on the volatility of the stock. This means deciding how much of your original capital you are willing to lose if the stock price falls after you purchase it.
And you need to commit to selling the shares if the stock price does fall; otherwise the losses in one company can wipe out the gains in the rest of your portfolio. Building discipline into the way you manage your investment account from the outset is the key to your long-term success in the stock market.
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