Share investing for absolute beginners
Published in the My Wealth Newsletter, Commonwealth Bank, June 2014 by Keely Double
Share investing has captured imaginations for decades with legendary tales of overnight success pitted against sordid stories of stock market crashes and a world of grey in between.
To a first-time investor simply looking to make the most of their savings, the intrigue of Wall Street can cast a daunting shadow.
But don’t be put off by the world you see in Hollywood films.
For most people, buying shares is not about trying to outsmart the market or get rich quick.
Rather, it is about choosing companies that look likely to do well over the long term and whose shares should, subsequently, increase in value over time.
What is a share and how do I buy one?
At its simplest, a single share represents a single unit of ownership in a company.
Companies like Commonwealth Bank of Australia, Rio Tinto and Woolworths are listed on the Australian Securities Exchange (ASX)—commonly known as the stock market or stock exchange—meaning anyone can buy and sell their shares.
Although these big names are among the most well-known, more than 2,000 companies are listed on the ASX.
When you buy shares in one of these companies—even a very small number of shares—you then own a small part of that business.
You need to use a third party called a ‘broker’ to conduct the actual transaction of buying or selling shares.
Most big Australian banks offer broker services and have online platforms where you can easily get started investing in shares.
For example, you can open a share trading account for free with MyWealth.
How can I make money from shares?
People aim to make money from investing in shares through one, or both, of the following ways:
- An increase in share price. Usually known as ‘capital growth’ or ‘capital gain’, all this means is that you make money by buying your shares for one price and selling them for a higher price.
- Conversely, it’s important to remember that if the share price falls below the amount you paid and you sell your shares at this lower price, you would lose money.
A share in the company’s profits. Usually known as ‘dividends’, these payments are a portion of company profits paid out to shareholders, usually twice yearly. Companies don’t have to pay dividends, but many see it as a way of rewarding their shareholders.
Isn’t my money safer in a savings account?
It’s true that savings accounts and term deposits are the least risky type of investment, and it is generally recommended you keep some of your money in these assets.
But investing in shares gives your money the chance to earn better returns than it would if you left it in a bank account.
Think about it this way.
Over the ten years to 31 December 2013, the average yearly return before tax from cash investments— meaning savings accounts—was significantly lower than the average from the Australian share market, according to a report by the ASX and Russell Investments.
- Cash investments – 3.7% per year
- Australian shares – 9.2% per year
Keep in mind that these figures for past returns aren’t a guarantee of what’s going to happen in the future, but they do give you a picture of how shares and cash investments have performed over the long term.
Taking the first steps
Thinking about why you want to invest can help you work out your strategy and avoid making irrational decisions down the track.
Janine Cox, investment analyst at Wealth Within, advises beginner investors to ask themselves a few key questions:
- How long do I want to put money into the stock market for?
- How much am I going to invest?
- Am I going to make regular contributions?
- How do I teach myself to invest?
Cox encourages anyone starting off on their investment journey to take the time to get the know-how.
Otherwise, she says, 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 get the knowledge you need, the quicker you can get to a point where you can be independent, Cox says.
It’s important to educate yourself about the economy, interest rates, exchange rates and government policy, and understand how these factors may affect a company’s performance, says the Australian Government’s MoneySmart website.
You should also learn the basics about how the stock market works, how to compare and choose companies, and how to manage your investments.
MyWealth Learn can help guide you, with information written especially for first-time investors. The ASX also has a share investing education section on its website.
How much do I need?
Cox says people are sometimes put off by getting together the lump sum they need to start investing.
She encourages people to set goals earlier and start saving towards making that initial investment.
There is no definitive answer to how much you need, although different brokers may have different minimum amounts. For example, to buy shares via the MyWealth trading platform, you need to buy a minimum $600 worth of shares at one time.
The ASX suggests you should “start your share investing with at least $2,000” as a rough rule of thumb, while Cox recommends aiming to invest a minimum of $2,500 into any one company.
Understanding the costs involved should help you decide how much you want to invest.
When you buy or sell shares, each individual transaction incurs a brokerage fee in addition to the price of the shares themselves.
This means the less you invest, the more the fees will be as a percentage of your total investment.
For example: If brokerage costs you $19.95 and you buy $600 of shares, brokerage will represent just over 3.3% of your investment.
If brokerage costs you $19.95 and you buy $5,000 of shares, brokerage will represent only 0.4% of your investment.
The point is, if you start with a small amount of money, the company you invest in may have to perform far above the average rate of return for you to make enough money to even cover your costs, let alone turn a profit, when you eventually sell your shares.
On the other hand, it is important to understand shares are considered the riskiest type of investment and the more money you invest, the more of your savings you are effectively opening up to that risk. You need to be comfortable with the possibility of losing your money.
How do I choose which shares to buy?
Researching and choosing companies to invest in can be enjoyable and there are lots of tips and recommendations to guide you through the process.
MoneySmart suggests starting with companies in an industry that you know something about, as this may make it easier for you to understand how a business is doing.
- Action: To research the different industries, try the MyWealth share sector dashboard. It’s free to use, and will give you an overview of how each industry has performed in recent years, as well as
highlighting the largest companies in each industry.
The fifty largest companies on the ASX are typically the least risky investment prospects for first-timers, says MoneySmart. This is because most of these are long-established businesses with a history of delivering steady shareholder returns. These are also known as ‘blue chip’ shares.\
- Action: To research blue chip companies, use the MyWealth blue chip dashboard. It lets you easily compare share prices, growth rates and broker recommendations on whether to buy or sell a particular company.
What am I looking for?
While past financial performance and achievements can be important indicators of the stability of a business, what really drives share prices is a company’s future outlook.
MoneySmart recommends asking questions like:
- Will the goods and services this company provides be in demand in the future?
- Are there opportunities for the company to grow?
- Who are the company’s competitors and are they in a strong position?
Sources like a company’s annual report, as well as its yearly and half-yearly financial results statements, can be good places to find relevant information. These can be found by searching for the company name on the ASX website.
MyWealth also lets you add shares you are interested in to your own personal watchlist, which can help you keep an eye on certain companies and see how much your money would have increased or decreased if you had made these investments.
Cheap but uncheerful
Unlike reduced prices on clothes or kitchenware, cheap shares don’t always represent good value for money.
Stay away from ‘penny stocks’, Cox emphasises. While they might look cheap at 10 to 20 cents per share, a small company with a shaky track record can wipe out your money faster than any big stock.
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 valued at around $60 per share.
What matters when it comes to making money is not how many shares you own, but how much each share increases in value.
Cox also cautions against buying shares just because prices are 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.
Look at companies’ share price charts for a historical view of share value, says Cox. If a share price has been falling over the long-term, that company would probably be considered a high risk investment.
- Action: You can view share price charts on MyWealth. Simply log in and search the company’s name to find its dashboard.
Not rising too quickly?
On the other hand, rapid and significant share price growth can also be cause for concern.
As mentioned above, share prices generally rise when a company makes a positive announcement about its future – for example, a contract for new business, a profit forecast or a sales outlook.
But if the share value grows too quickly and the company doesn't deliver on its forecast, the prices may well fall again as the shares become less desirable.
Basically, price is definitely important when choosing shares, but it should always be considered alongside a range of factors.
How much am I willing to lose?
Selling decisions are as critical as buying decisions to your results in the share market, MoneySmart notes.
Cox agrees, suggesting you should decide at the point when you first invest how much money you are willing to lose.
“A lot of people are quite happy to buy but don’t know how to sell,” she says.
Cox recommends setting yourself a ‘percentage stop’ of around 15% for each company you buy shares in.
This means deciding how much of your originally invested money you are willing to lose.
Once a company’s share price falls below this amount, you commit to selling those shares.
Otherwise losses in one company can wipe out gains in the whole rest of your portfolio, Cox says.
Building discipline into the way you manage your investments from the start will be key to your success moving forward, Cox advises.
If you would like to learn how to gain the required knowledge to ensure your success in the stock market click here.
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