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 such as 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. 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.
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 a year. Companies don’t have to pay dividends, but many see it as a way of returning earnings to their shareholders.
Isn’t my money safer in a savings account?
It’s true that savings accounts and term deposits are a less risky type of investment, and it is generally recommended you keep some of your money in these assets.
But investing in shares can give your money the chance to earn better returns than it would if you left it in a bank account.
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. Ask yourself a few key questions:
- How long do you want to put money into the stock market for?
- How much are you going to invest?
- Are you going to make regular contributions?
How do you learn to invest?
The sooner you start to get the knowledge you need, the quicker you can get to a point where you can feel confident.
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.
The ASX also has a share investing education section on its website.
How much do you need?
There is no definitive answer to how much you need, although different brokers may have different minimum amounts.
The ASX suggests you should “start your share investing with at least $2,000” as a general guide. 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.
- If brokerage costs you $19.95 and you buy $600 worth of shares, brokerage will represent just over 3.3% of your investment.
- If brokerage costs you $19.95 and you buy $5,000 worth of shares, brokerage will represent 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 the money you put into the share market.
How do you 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.
What to look 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 such as 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.
Cheap but uncheerful
Cheap shares don’t always represent good value for money.
While ‘penny stocks’, for example, might look cheap at 10 to 20 cents per share, a small company with a shaky track record has the potential to wipe out your money fast.
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.
Be wary, too, of 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. If a share price has been falling over the long term, that company would probably be considered a high risk investment.
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 might fall again as the shares become less desirable.
Basically, price is definitely important when choosing shares, but it should always be considered as part of a range of factors.
How much are you willing to lose?
Selling decisions are as critical as buying decisions to your results in the share market, MoneySmart notes.
Consider 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 may wipe out gains in the rest of your portfolio.