By Guy Norman
I believe that stocks are the best tool for the long term investor. Investing is a completely democratic operation. Irrespective of gender, race of religion – as long as you have access to some money and basic know how you can get involved So, in this the second part of my beginners guide to the stock market I am exploring where returns come from, the optimum length of time for investment and the choice of different funds. To see my first feature please refer back to part 1.
NB: I am only going to attempt to explain investing in stocks, not any other investing instruments. Also, the information below is designed to be a guide. It doesn’t constitute advice re investing in any specific product or stock. Always consult an expert before you invest your money in anything.
Where Do My Returns Come From?
If you’ve invested your money in stocks then your returns can come in the form of dividends or an increase in the price of your stocks. When a company thinks they can no longer effectively re-invest all of their profits back into their industry they can regularly return some of their profits back to their stockholders. The ‘dividend yield’ for a stock is the annual dividend the owner of the stock will receive, expressed as a percentage of the current stock price. These dividends can then either be spent or used to buy more stocks. The price of your stocks will increase typically increase when the value of your business increases. Your business gets more valuable as it gets more profitable and more secure in its position in the market.
How Long Should I Invest In The Stock Market?
The best answer to this question is for as long as you can. A bad answer to this question is probably anything less than 5 years. If you might need to spend that money in less than 5 years’ time then you shouldn’t invest it into stocks. The price levels of stocks, in the short term, are too unreliable and volatile to be relied on.
Ways To Invest In The Stock Market
There many ways of investing in the many stocks. I’m going to explain the difference between actively and passively managed funds, the stock markets of different countries and doing your own stock picking.
Worldwide there are many investing products available where, for a fee, you can have your money invested in the stock market. The choice of different funds can be huge. There are funds specialising in smaller companies, larger companies, American companies, ‘Emerging Market’ companies, and companies from certain industries. There are funds that invest in other funds. Investing funds can provide a great service to the non-expert. They can diversify your portfolio and avoid making some of the mistakes a non-expert might make. There are two kinds of funds – active and passive. An active fund uses expertise to try and pick stocks that will yield an above average return. A passive fund will blindly buy a wide range of stocks or investment products. All of these funds will charge you for their services.
Half of all fund managers (people who you might pay to manage your ‘active’ funds)are below average. That is a mathematical certainty. These fund managers’ fee will come out of your savings and reduce your returns. Facts like these are causing investors increasingly to invest in passive funds which charge very low fees and aim at an average return on the stock market.
Passive Funds blindly invest in a number of different stocks, bonds or other investment products. You might think that this is a pretty dangerous way to invest your money but often such funds have often done well for their investors. For example in America, Vanguard’s “500 index fund” has diversified its investor’s savings across the S&P 500 Stock Market index and has a 10-year average return of about 7.5% as of the end of 2014. Vitally Vanguard charges only 0.17% of your savings for doing so. Passive funds do not rely on your choosing a fund manager whose investing ability is better than the average. In a common type of passive fund a ‘stock index tracker’ your money effectively buys a tiny amount of each stock the fund targets. You thus get a return similar to the average performance of that stock market, after the passive funds fees. These fees are often far lower than those for an active fund. Furthermore investing in a passive fund will give you a lot of diversity in your portfolio.
The diversity of your portfolio is how exposed your investments are to any one kind of risk. A diverse portfolio is essential to almost all investors. If you invest in a number of industries and a number of countries, you are less likely to see the prices of all your investments suddenly decrease because of any one cause. A decrease in almost all stock prices last happened in 2009-2010 and history shows us that it will happen again. However history also shows us that, if we have patience, the prices of stocks will rise again.
The value of a corporation and thus the price of its stock depends on the profitability of its future. In addition to the risks involved in competing in a marketplace the risks of fraudulent management, corruption, state seizure, political violence are prevalent to different degrees in different regions. Corporations in countries that investors think are ‘safer’ will, other things being equal, have more expensive stocks. If you can it is wise to diversify your portfolio so as not to be overly exposed to any single source of political risk from any one region in the world. Iraq currently has two stock exchanges – the Iraq Stock Exchange and the Erbil Stock Exchange. The Erbil stock exchange, based in Iraqi Kurdistan being far smaller than the now established Iraq Stock exchange. Iraq, as I’m sure you’re aware, suffers greatly from political and violence risk. If you are going therefore to invest any of your money into Iraqi corporations I would recommend against investing a majority of it.
If you want to find out more in the meantime, a free course about investing in the stock market is offered by Udemy.com.https://www.udemy.com/value-investing-code/
Part 3 – out 24th March: Stock Picking. A Brief Introduction to Valuing A Stock. How Can I Find A Stock Broker In Iraq?
(Refer to part 1 here)
Questions? Get in touch with Guy at twitter, @the21stgman. Guy is happy to answer any questions.