While investing in stocks can seem quite complicated, and even scary, it nevertheless offers a great opportunity for returns. As with any new venture, getting the basics right is the first of many steps if you want to enter the exciting world of stock markets.
What are Stocks
In very simple terms, stocks can be defined as an equity investment into a corporation giving the owner certain rights, such as the right to vote in shareholder meetings or receive dividends if and when they are available, or a right to a claim on part of the company’s assets if said company liquidates or declares bankruptcy. An investor can also sell or trade the stocks they own to make profits. Alternatively, they might incur losses, depending on the performance of the company.
In the UK, the main equity market is the London Stock Exchange (LSE) with its various indices, such as the FTSE 100, which features the UK’s largest 100 companies, or the FTSE 250. There is also the alternative investment market which is the LSE’s market for smaller, growing companies.
Why do People Buy Stocks
As with any financial investment, stocks carry a certain amount of risks – shareholders can lose out on their initial investment if a company performs poorly – the financial news world is full of horror stories of profit warnings, falling revenues, not to mention stock market crashes, all making it seem investing in stocks is not for the faint of heart. Despite that, stocks remain one of the most popular forms of financial investments, offering two main routes for capital returns.
The first one is capital appreciation where the investor looks to buy the stock at a certain price and sell it at a higher price. The other one is income which the stock can potentially deliver in the form of dividends – ordinary as well as special payouts if a company is doing particularly well.
Benefits of Buying Stocks
With so many forms of investments out there – let’s face it, if you have some money, there will always be people eager to take it – it’s important to know the benefits of each one to make an informed decision. The main benefit of stocks is ownership since buying a stock implies owning a stake in the company – however minuscule it maybe – which would entitle you to a vote on certain decisions, and to receive updates on the company’s performance, etc.
Stocks also offer diversification – they can be an addition in a portfolio which also contains other investments such as precious metals, real estate or bonds, and as such potentially offer a hedge against losses elsewhere in the portfolio. Stocks also offer inherent diversification – while the stock market as a whole may suffer sharp rises and falls, shares in companies from different industries could perform differently. For instance, cyclical stocks such as banks and miners are more susceptible to the ups and downs of the global economy, while defensive shares, such as utilities, tend to outperform the rest of the market during recessions while underperforming in periods of expansion.
How to Choose a Stock
The diversity of stocks, however, does have one drawback – it makes it difficult to choose which company exactly to invest in.
Fortunately, there are some simple rules that can help you at least narrow the ocean of stocks down. A good starting point would be either an industry or a company that you are familiar with; alternatively, you can do some research – both into individual companies and the industry as a whole – it would mean reading financial statements, following news, as well as analyst comments, which could help you determine if a stock is ‘undervalued’ or ‘overvalued’ at a certain point of time.
If it is income stocks you’re after, it is important to check the history of the company’s dividends and to track if those payouts have been increasing over time.
Investing Directly vs. Indirectly
If the prospect of researching individual stocks seems too daunting, it is important to know that it is not the only way to invest in the stock market. Buying stocks means investing directly since it equals buying shares in a single company and becoming a shareholder. There is, however, the option of investing indirectly, through funds, which spread risk by investing in different companies.
Mutual funds are one such option – they pool investor money and put it into a number of companies. This means that if you invest in a mutual fund, you invest in many stocks simultaneously, with a single transaction. Exchange-traded funds (ETFs) also deserve a mention here – they are investment vehicles which track the movement of indices, such as the FTSE 100 or the FTSE 250.
The upsides to indirect investments include diversification and by consequence, less risk than buying stocks outright. Indirect investment is also a good option for beginners, or for those who cannot afford to spend much time on researching individual companies and building stock market expertise, since mutual funds and other investment vehicles are managed by experienced professionals. The downsides include management fees, and the fact that indirect investing means that you won’t be a shareholder in a company. Indirect investments can also spell weaker returns than direct investments in cases where a company sees a sharp rise in the stock price.
Opening an Account
Once you have decided that you want to take a shot at the stock market, you should proceed with opening an account. The most straight-forward way is opening a brokerage account – if you choose to go with that option, you should research brokers beforehand to choose one that you are comfortable with. Important things to pay attention to are fees and trading commissions, as well as any requirements for a minimum deposit.
A relatively recent alternative to brokerages are robo-advisors which basically rely on computer algorithms to make investment decisions. While this option might seem less appealing to those looking for a more hands-on approach to investment, it has the advantage of being cheaper – according to a recent article in Time’s MONEY magazine, wealthy clients typically pay human advisors one to two percent of their investable assets annually for managing their portfolios, while with robo-advisors, the average management fee is roughly a third of traditional human advisors, or just 0.36 percent. Investopedia meanwhile has cited a report by Charles Schwab which indicates that 58 percent of Americans will use some sort of robo-advice by 2025.
Setting a Budget
That brings us to setting your stocks investment budget. While it is contingent on your personal circumstances and how much money you are willing to lock up in stocks, it is important to take into account the trading fees, commissions and potential minimum deposit of the online broker/robo-advisor you end up choosing. Mutual funds often have minimums of $1,000, while some financial institutions require bigger amounts. ETFs tend to be a cheaper investment option, the downside being that since they simply track an index, if the index falls, your investment will follow.
While investing in stocks is a very complex matter, there are plenty of tools and information available to help beginners learn how to formulate their own strategy and build a diversified portfolio.