Investing in shares.
Investing in shares is becoming more and more accessible to a greater number of investors through online share trading platforms. However, the usual risks still apply so it pays to have an understanding of what you’re investing in, and why, to help achieve the financial goals you’re after.
What is a share?
Shares, stocks, equities, and securities are all types of financial instruments that can be traded ie bought and sold. Shares are a portion of ownership in a company. When you buy shares in a company you become known as a shareholder and have various rights and responsibilities, such as possibly receiving a portion of the profits, voting rights at Annual General Meetings, but also the potential to lose all or part of your investment if the company doesn’t perform well.
Why invest in shares?
Shares are an attractive investment for many people as they offer potential for both capital growth (ie an increase in the value of a share) and income (ie dividends) though neither are guaranteed. Other benefits of investing in shares include:
- Liquidity – investors can enter and exit the market quickly and easily, meaning if you need urgent access to your money, it’s a relatively simple process.
- Lower entry level – unlike investing in property where you need to firstly save a large deposit, you can get into the share market with as little as $500.
- Lower costs – compared to other assets, like managed funds and real estate, stock market investments typically incur lower costs.
- Dividend reinvestment plans – allow investors to receive their dividends as more shares in the company rather than money in their account. Not all companies offer this service though.
How does the share market work?
The share market (also referred to as a stock exchange) is a transparent, regulated, electronic marketplace which brings together buyers and sellers to trade shares in public companies.
In Australia, our share market is the Australian Securities Exchange and is referred to as the ASX. Recent legislative changes have seen Chi-X commence operation here too, further expanding access to different financial instruments to invest in.
How to buy shares.
There are 3 channels that you can use to interact in the stock market and invest in shares.
- A financial planner who would potentially provide you with advice on which shares to buy and sell and then make the transactions on your behalf.
- An advisory broking service (also known as full-service brokers) who again could provide you with advice and manage the transactions.
- A non-advisory broking service, often online, through which you can buy and sell shares yourself without receiving advice, such as Westpac Share Trading.
There are advantages and disadvantages to each so research the costs, benefits, reviews from others, and your own knowledge and comfort level before choosing which channel may suit you. You don’t need to stick with just one either. You may wish to use a financial planner for the bulk of your investments and use an online broking service for your own interest and dabbling with small amounts.
What are the risks when investing in shares?
As with any investment there is always an element of risk. Trading in shares is considered to have a medium-to-high level of risk, due to some of the following factors.
- Volatility – one of the key risks when investing in shares is the possibility of share prices changing rapidly. Share prices are based on past performance of the company as well as the perceived future value of shares – either through the payment of dividends or through anticipated capital gains. If the business is performing well then share prices generally increase as more buyers look to take advantage of an opportunity to make more money. However, share prices can also fall quickly if the business is not performing well or there is a perceived future disadvantage with sellers offloading shares to offset future losses.
- Market risk – this is the risk that the stock market will experience losses due to economic and financial performance factors. This could be due to legislative changes, changes in governments, changes in other markets that influence the ASX, global economic changes due to natural disasters etc. You could also include foreign exchange risk here too as changes in currencies may impact returns or values on international shares.
- Credit risk – this is the risk that the company you invest in fails. Shareholders are generally the last in line to be paid after all other creditors which can mean there is not enough to go round, and you may lose some or all of the money you have invested.
Effectively, the risk of investing in shares, is that you will not get your money back or that the returns will not be as high as anticipated. However, by researching, learning, and analysing your investments carefully, you give yourself more opportunity to understand the stock market and manage these risks.
One way to help reduce the risks when buying shares is to create a diversified portfolio. Your share portfolio is simply the collection of different shares that you own. By spreading your risk and buying shares from different companies and different industries you improve your chances of being able to ride out any downturns or volatility with particular shares or industries.
How to make money from shares.
There are lots of different strategies regarding how to make money from shares. The two most common ways are through what are called dividends, and capital gains. It will depend on your personal situation and financial goals as to whether you are looking for long-term capital gains (ie increases in value) or regular income from dividends to supplement your cash flow.
- Dividends – Dividends are the share of the company's profits that it distributes to its shareholders. When a company earns money, it might choose to pay out some of its earnings to shareholders. It is important to note that some companies do not pay out dividends (they have no obligation to), so when you do your research keep an eye out for DPS (dividends per share) and how they may have changed in recent years depending on the business’s profitability. Look for companies that consistently pay dividends and compare the amount of the dividend with the price you pay for the shares. For example, if you pay $10 for a share and it provides a half yearly dividend of $0.25 this equates to a 5% return on your investment. Then compare this with other investment opportunities to decide if it’s an acceptable return to you.
- Capital growth – Capital growth refers to the increase in the value of a share price over time (or capital losses if the shares decline in value). On the stock market, the value of shares may increase and decrease daily. If you buy a share for a lower price and sell it at a higher price, the money you have earnt is called capital gains. For example, if you pay $10 for a share and 12 months later that share is selling for $12, this equates to a capital gain of 20%. To realise that capital gain though you need to actually sell the share. On the other hand, if the value of your share goes down, while it’s technically a loss, you don’t crystalise that loss until you sell the share. So, if you keep the share, you give yourself the opportunity to recoup that loss should it increase in price in the future instead of losing money now.
What you’re looking for in a share will depend on your investment strategy. If you are looking for a steady income, aim to invest in shares that pay regular dividends. If you are looking for long term growth, then you may want to look for capital growth. You may find yourself in a win-win situation if you can find shares that pay regular dividends and have capital growth.
How do I research shares?
The ASX website has current and historical information about the shares it trades. You can also get regular updates and information from online broking houses. If you know the unique identifier for the share (for example Westpac’s identifier is WBC), then you can simply type that into Google and you have up-to-date and historical information at your fingertips.
If you want to go a bit deeper, all publicly-traded companies are required to publish their financial statements. You can find these online by searching for them or checking for annual reports on the company website (sometimes called investor portals).
For more information on what to look for when researching shares, the ASX website has a number of online courses.
How much to invest in shares.
As we said at the outset, recent developments in technologies, new trading platforms, and trading apps means investing is much more accessible now, so more people are getting into the share market, and sooner than traditionally.
So, how much should you invest in the share market? This will depend on how much you have available to invest and your broader investment strategy. You may want to consider having your personal finances sorted with a budget in place for your everyday spending and a healthy emergency fund for the unexpected before you start investing. This will help make it clearer how much you are able to invest. Bear in mind how much you are prepared to lose on an investment and think carefully before investing more than this.
With lower entry levels now available, if you’re a beginner to investing you may feel more comfortable starting with small amounts. Once you become more familiar with the processes and strategies, you can incrementally add more cash to your investment pool and build your share portfolio to help achieve your financial goals.
Before you begin.
Before getting down to work, ensure you are clear on your financial situation, your investment goals and investment strategy. Ask yourself:
- What are you looking to achieve – income or capital growth?
- What is your risk appetite?
- How much do you want to invest?
- How long are you willing to keep the investment?
- How much are you prepared to lose?
Final share investing tips.
- Do your research.
The more research you do, the better informed you will be to make sound decisions. It’s good practice to set up an investment strategy and do your due diligence before you invest.
- Feel confident.
It can be daunting investing your hard-earned money in shares for the first time. The stock market is volatile by nature and prices may go up and down every day. But, be confident in your research, stick with your investment plan, and don't be alarmed by daily price changes.
- Act rationally.
Base your decisions on your research not your gut reaction. Just because you like a brand or company, doesn’t necessarily mean it’s a good investment.
- Diversify your investments.
It’s safer to avoid having all your eggs in one basket. You might decide to invest in different assets, markets, and industries to diversify your portfolio.
- Regularly review your portfolio.
No matter the size of your portfolio, it’s wise to regularly review the make-up of your portfolio and risk level, the returns it’s achieving, and whether it’s still working towards your ultimate financial goals. This improves your knowledge and helps you take advantage of opportunities as they arise and may provide an early warning of potential troubles ahead.
Learn more with online investment courses.
The ASX is the Australian Stock Exchange and is the primary financial market in Australia. The ASX has a series of online courses that will help you learn more about shares, options, ETFs and ETPs, corporate bonds and government bonds. The ASX also offers a wealth of resources and investment tools that will help you conduct research. If you want to test your investment strategy before using real money, you can invest in a real-time simulation of the stock market with the ASX stock market game.
Where to get help?
This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice. © Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.