What Are Stocks?
Stocks or Shares were once upon a time a piece of paper which proved your ownership of a company. These days all shares are traded online (some companies do still issue paper stocks at your request) but their purpose remains the same, a share held represents partial ownership of a company. If Microsoft is made up of 10 shares and you own 1, then you own 10% of Microsoft.
If you’re a new investor, you might be wondering why you would want to own a share of a company. The most straightforward reason is that over the long run, stocks have provided the highest returns. This is both a positive and a negative as with high returns comes high risk, we’ve seen it in the past during the Dot Com bubble of 2001, the global financial crisis (GFC) of 2007-2008 and we’re currently seeing it in 2020 due to the Coronavirus outbreak.
What Are the Expected Returns of Owning Stocks?
Since 1900 the Australian stock market has returned an average of about 13%. There’s no guarantee that this rate of return will continue into the future but for this example, let’s assume it does. If you were to invest $1,000 for 20 years with 13% returns, your investment would turn into a bit over $13,000. This is a higher return than you could expect with just about any other asset class. Substantially higher than one of Australia’s most popular asset classes, ‘property’ which clocks in at returns of about 6.8% over the past 25 years.
What Are the Risks of Owning Shares?
While shares do provide the best returns on average of any of the major asset classes, they aren’t risk-free. We mentioned above that Australian stocks have grown about 13% per year over the past 120 years, but that’s not to say that you can’t lose money on the stock market. Individual stocks can be hazardous investments with some not growing at the market rate, some not growing at all and others even going bankrupt. If you’re thinking it’s okay I’ll just pick the winners it’s worth noting that in 2019 the S&P Dow Jones Indices released a report stating that over 15 years almost 92% of professional money managers failed to beat the market.
How Can You Reduce Those Risks?
The good news is that you don’t need to pick stocks to achieve the market return. With the invention of Index Funds, you can now invest your money into a fund that buys every company on the market. The fees are low, and the returns are around those achieved by the market, meaning that over the long run, you will likely experience returns higher than 90% of professional investors.
Vanguard is widely considered the leader in the Index space; they did create them after all. At the time of writing this, they currently offer the lowest fees and offer indexes that track many markets around the world, if you would like to learn more about Vanguard and some of their more popular products you can do so HERE.
Are Stocks the Best Allocation of Your Money?
Generally speaking, the best approach to investing is a densified portfolio of assets. This means that you are not only diversifying by purchasing different assets like multiple stocks but also different asset classes like bonds and savings accounts. How much of each is right for you will differ based on your age and risk preferences. If you expect to be working and adding to your investments over the next 20+ years, it is usually a good idea to include a higher portion of shares in your portfolio. If you are looking to retire in the next 5-10 years it is typically a better idea to hold a lower percentage of stocks as although they do on average provide the best returns, they do also pose some of the most significant short-term risks.
How Can You Buy Shares?
Once upon a time, buying shares was a difficult thing to do but with countless advances in technology, it is now easier and cheaper than ever. If interested in buying individual stocks you will need a broker, there are myriad options each with different benefits and costs so do your research, but I would suggest that the cheapest is usually the best. I personally use Saxo Capital, but the best option will differ based on the size of your investment and the products that you want access to.
If I’ve managed to convince you that it’s not worth trying to beat the market with individual stocks and you’re looking to jump into the market by investing in an index fund that will likely provide you better returns anyway. There are several ways to invest based on whether you are investing in a fund that is exchange-traded or not. More information on that process can also be found HERE.