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Equity space from time past had been a better profit-returning sector if compared to the performance of the fixed income space. Sector players tend to put a larger portion of their investment in equities than other asset classes like bonds, commodities, real estate, and consumer goods. This article will expose the inherent benefits that await you for investing in shares as well as enlighten you on the possible pitfalls you must avoid as an avid investor.
Purchasing shares (or stocks) entails acquiring a portion of a publicly traded corporation. There are two main ways that you can benefit: Dividends (getting a cut of the company’s income) and capital growth (selling shares for more than you paid for them).
Here are the specific ways you benefit as a shareholder:
1. Capital Appreciation (Growth)
When a company performs well and grows, demand for its shares increases, driving up the share price. If you buy a stock at $50 and the price rises to $90, you make a profit of $40 per share if you sell. This compounding growth over the long term is one of the most effective ways to build wealth and beat inflation.
2. Dividend Payouts
Many established companies share their success with investors by paying out a portion of their profits, known as dividends. These payments can give you a steady stream of passive income. You can choose to withdraw the cash or automatically reinvest it to buy more shares.
3. Ownership and Voting Rights
Holding shares makes you a part-owner of the business. Depending on the type of shares you hold, this often comes with voting rights, allowing you to have a say in major company decisions and board elections at the annual general meeting (AGM).
4. Liquidity
Unlike physical real estate, shares are highly liquid. If you suddenly need cash for emergencies, you can sell your shares on the stock exchange during market hours and have the funds available in a matter of days.
To begin with, you will be better off if you understand the basic definitions of stock investment:
Shares:
A share can be defined as a unit of ownership that represents an equal proportion of a company’s capital, this is a representation of the portion or part of a company that you as an investor owns. When you buy a share, you are referred to as a shareholder because the payment of dividends affords you a small percentage of everything that the company owns, for example, buildings, equipment, computers and other assets.
As a shareholder of a company, you have the right to make decisions that can influence the company, as you also have equal claim on the company’s profit and an equal obligation for the debts and losses of the company.
There are two(2) types of stocks, the ordinary shares and the preference shares. Ordinary shares are those traded privately as well as those traded on the various stock exchanges around the world. You should know that the true value of an ordinary share is based on the price obtained through market forces, the value of the underlying business and investor sentiment toward the company. Investors always have a voting right and also bear the liability of the company in the event of a winding up.
Preference shares are shares that afford the investor a higher claim on the assets and earnings than ordinary shares, with reference shares you receive dividend that must be paid out before dividends are paid out to ordinary shareholders though the shares usually do not have voting rights. You can purchase preference shares in the primary market, public offers and the secondary market and these are usually brokered by stockbroking firms who in turn earn commission on the trades executed on your behalf.
What you stand to gain for investing in shares are simplified below for easy understanding of the dynamics of stock investing:
1. Capital Appreciation:
On a good day, one of the gains of investing in shares is capital appreciation, capital appreciation is the amount of increase found in the principal value or the price per unit of a share. This is also a rise in the value of an asset based on a rise in market price. In essence, the capital you invested in the security has increased in value and the capital appreciation portion of the investment includes all of the market value exceeding the original investment or cost basis. You should note that capital appreciation is one of the two main sources of investment returns, with the other being interest income or dividend.
2. Dividend:
This is a portion of a company’s earnings, decided by the board of directors and approved at the company’s annual general meeting to a class of shareholders like you. This dividend is most often quoted in terms of the amount each share receives(dividends per share) or it can be quoted in terms of a percentage of the current market price, referred to as dividend yield. It should be noted that dividends may be in the form of cash, stock or property as most secure and stable companies offer dividend to shareholders but high-growth companies rarely offer dividends because they apply all of their profits for re-investment to help sustain higher-than-average growth.
Share prices might not move much, but the dividend pay-out attempt to make up for the slow movement.
3. Owning Quality Companies:
Owning shares in quality companies make you to get the privilege where the board of directors effectively work for you and ensure you get good returns thereby maximizing your wealth. The fiduciary responsibility of the board of directors are usually tailored in a way that will always benefit you as shares have the potential to generate good returns. Please note that shares can also be risky so you should have a long-term investment plan at the back of your mind as you should be looking at 3-5 year time frame to maximize your investment.
4. Attractive Returns:
Historically, shares have had better returns compared to other investments, such as cash in the bank and bonds. You should bear in mind that past performance of a stock is not a guarantee that the stock will perform in the future as there are many determinants of stock price movement. Saving in a bank do not also provide good returns when you factor in inflation, for example, you may be happy if a bank offers you 12% interest per annum on your term placement, but if you factor in inflation around 8.6% (depending on your region or country), then your investment is only growing at a mere 3.4% per annum. To have a growing investment, you definitely need capital growth, translating to share price increases beyond inflation which is the general increase in the cost of things you buy daily.
5. Ease Of Diversification:
Stock investment is flexible as it affords you the opportunity of ease of diversification. You are said to diversify when you explore many investment options by not concentrating on one particular company or stock, if you make smaller investments in various different companies, the probability that one of your investments fails means that it would not have a great effect on your total investment thereby shielding you from any possible downturns, since you can buy a small number of different shares.
6. Liquidity:
Quoted stocks are usually liquid in nature and this makes them very attractive as an investment option. Shares have a large market, for example, the blue chip companies, hence you can have buyers and sellers to fulfil your request, especially when you want to liquidate your portfolio as opposed to where you want to sell property, where you may have only one or two interested buyers.
7. Free Flow Of Information:
Most financial websites, newspapers, and news on TV are the major sources of information about a particular company’s share as you can get to know the minute value of their share portfolio. To get you updated on your investments, the listing rules around the major stock exchanges in the world require that companies must report information to shareholders, including financials(full year and half year) news that may affect the share price, such as acquisitions and divestments and response to queries relating to large movements in share prices.
Some Pitfalls You Must Avoid While Investing In Shares
The equities market is indeed a unique space with constantly evolving dynamics, from operators to the regulators and even you as an investor; this demands a devotion to processes and practice to ensure that expectations are met. If you desire to play in the market space, you will do well to update your knowledge before entering the market. There are lots of benefits in stock investment, though these are not without some pitfalls, especially when you lack the understanding of how the stock market works and when you make the wrong choices.
Read Also: How Does Forex Differ From Stocks?
For your attention, these likely pitfalls are enumerated below:
* Risk Of Ownership:
There is no controversy over your right as part owner of the company you invested in but when bankruptcy is declared, you should bear in mind that you will be one of the last to persons to receive any proceeds from the liquidation of the company or more often, you do not receive any at all. Companies go into liquidation sometimes and thereby erode the investments of ordinary shareholders therefore, you must be vigilant to watch over your investment if you consider it important to you. You may also engage the services of an experienced Investment Manager.
* Fraudulent Stock Brokers:
Activities of fraudsters may not be ruled out completely in stock investing; it is, however, your responsibility to detect and avoid these misfits as they operate by collecting money when there is perceived information that the shares of a particular company are a good one and instead of making the transactions in your name, they will divert the money for their selfish interest. You should therefore be selective in picking your stockbroker.
* High Volatility:
You should also take note that share prices can go up or down for one reason or another. Sometimes, share prices drop so much that they may not provide you with retirement income in the form of dividends from stocks. As a discerning investor, you should, however, know what to do at times like that.
10 Things to Consider Before You Make Investing Decisions
Before you make any decision, consider these areas of importance:
1. Draw a personal financial roadmap
Before you make any investing decision, sit down and take an honest look at your entire financial situation — especially if you’ve never made a financial plan before.
The first step to successful investing is figuring out your goals and risk tolerance – either on your own or with the help of a financial professional. There is no guarantee that you’ll make money from your investments. But if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the years and enjoy the benefits of managing your money.
2. Evaluate your comfort zone in taking on risk
All investments involve some degree of risk. If you intend to purchase securities – such as stocks, bonds, or mutual funds – it’s important that you understand before you invest that you could lose some or all of your money. Unlike deposits at FDIC-insured banks and NCUA-insured credit unions, the money you invest in securities typically is not federally insured. You could lose your principal, which is the amount you’ve invested. That’s true even if you purchase your investments through a bank.
The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals. The principal concern for individuals investing in cash equivalents is inflation risk, which is the risk that inflation will outpace and erode returns over time.
3. Consider an appropriate mix of investments.
By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can help protect against significant losses. Historically, the returns of the three major asset categories – stocks, bonds, and cash – have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you’ll reduce the risk that you’ll lose money and your portfolio’s overall investment returns will have a smoother ride. If one asset category’s investment return falls, you’ll be in a position to counteract your losses in that asset category with better investment returns in another asset category.
In addition, asset allocation is important because it has a major impact on whether you will meet your financial goal. If you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. For example, if you are saving for a long-term goal, such as retirement or college, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio.
4. Be careful if investing heavily in shares of an employer’s stock or any individual stock
One of the most important ways to lessen the risks of investing is to diversify your investments. It’s common sense: don’t put all your eggs in one basket. By picking the right group of investments within an asset category, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain.
You’ll be exposed to significant investment risk if you invest heavily in shares of your employer’s stock or any individual stock. If that stock does poorly or the company goes bankrupt, you’ll probably lose a lot of money (and perhaps your job).
5. Create and maintain an emergency fund
Most smart investors put enough money in a savings product to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.
6. Pay off high-interest credit card debt.
There is no investment strategy anywhere that pays off as well as, or with less risk than, merely paying off all high-interest debt you may have. If you owe money on high-interest credit cards, the wisest thing you can do under any market conditions is to pay off the balance in full as quickly as possible.
7. Consider dollar cost averaging
Through the investment strategy known as “dollar cost averaging,” you can protect yourself from the risk of investing all of your money at the wrong time by following a consistent pattern of adding new money to your investment over a long period of time. By making regular investments with the same amount of money each time, you will buy more of an investment when its price is low and less of the investment when its price is high. Individuals who typically make a lump-sum contribution to an individual retirement account either at the end of the calendar year or in early April may want to consider “dollar cost averaging” as an investment strategy, especially in a volatile market.
8. Take advantage of “free money” from the employer
In many employer-sponsored retirement plans, the employer will match some or all of your contributions. If your employer offers a retirement plan and you do not contribute enough to get your employer’s maximum match, you are passing up “free money” for your retirement savings.
9. Consider rebalancing the portfolio occasionally
Rebalancing is bringing your portfolio back to your original asset allocation mix. By rebalancing, you’ll ensure that your portfolio does not overemphasize one or more asset categories, and you’ll return your portfolio to a comfortable level of risk.
You can rebalance your portfolio based either on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular intervals, such as every six or twelve months. The advantage of this method is that the calendar is a reminder of when you should consider rebalancing.
Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you’ve identified in advance. The advantage of this method is that your investments tell you when to rebalance. In either case, rebalancing tends to work best when done on a relatively infrequent basis.
10. Avoid circumstances that can lead to fraud
Scam artists read the headlines, too. Often, they’ll use a highly publicized news item to lure potential investors and make their “opportunity” sound more legitimate. The SEC recommends that you ask questions and check out the answers with an unbiased source before you invest. Always take your time and talk to trusted friends and family members before investing.
Having read this article, it is believed that you are now better equipped to decipher what you stand to gain for investing in shares and make the right choices that could improve your finances at all times.
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