Talk to a friend, family member or work colleague about investing in the stock market and they would think you are crazy. The majority of people still have the belief that the stock market is extremely risky. They have this view that stocks are ticker symbols which go up and down on a whim. There is this notion that stock picking is akin to gambling.
But for those that understand how the stock market works, it is far different to the situation mentioned above. In this series of articles, I will aim to give a breakdown of the stock market in an easy to understand manner.
The first lesson is to do with why one should invest in shares. Sure they are other asset classes, like property, bonds, commodities or fine art. But why should one invest in shares as opposed to all the other classes of assets?
To help with answering this question, let me tell you about my own story of how I started investing in shares.
About 4 years ago, I read a book called Rich Dad Poor Dad by Robert Kiyosaki. I am not exaggerating when I say that this book truly changed my life. It opened my eyes and lead me down a rabbit whole. It showed me the importance of owning assets – anything that putts money in my pocket – and avoiding liabilities – anything that takes away money from my pocket.
After reading the book, I realised that the only asset I had was my job. My job was the only thing putting money into my pocket. By I replied my job is not really an asset. Because I could get fired at any time. Just look at the countless stories of people getting fired on a whim during the financial crises. And if I lost my job, I would have no earnings to fall back on. This was a scary thought.
So I began to research ways in which I could make extra income outside my job. The way which kept cropping up time and game is to become an entrepreneur. To open my own business. That way I could be my own boss and not have the fear of getting sacked. But the problem is I don’t have the entrepreneur gene within me. I wouldn’t know which business to open. I knew the failure rate of start ups is 90% . And most of all, becoming an entrepreneur requires a lot of time and would certainly mean quitting my day job. I was looking for something more passive.
Instead of giving up, I kept researching. I had a decent chunk of change at the time so I asked myself the question ‘I can use money to buy almost anything, so why can’t I use it to buy more money?’ . And then I realised, that is exactly what investing in. Putting aside some money today to gain more money in the future.
So I looked at what I could invest in. The obvious answer was property. Rental property is the first thing that comes to mind when you talk about passive income.They are obvious draws towards it. Many people have done it before and its a proven way of making money. But it wasn’t the way for me. But the obvious pitfall for me was capital. You need a lot of money to start off.
There are a number of other drawbacks about investing in property. You need to find reliable tenants. You need to find reliable tradesman to fix items as soon as they are broken. Scalability issues. It is illiquid. The tax system is slowly moving against landlords.
And that is when I stumbled upon the stock market. And I almost gave up at this point. That is because like most people, I was of the notion that the stock market was akin to a casino. A place where stocks moved at random and people gambled away there life savings.
But I began to educate myself. I read hundreds of investment books and articles and listening to countless interviews and podcasts. Bit by bit, it started to make sense. Bit by bit, I learned that the stock market was not a giant casino, it was in fact the greatest wealth generating tool ever created.
I learnt that rather than starting my own company, I could invest in companies that were already successful. I learnt that I could invest in the best companies such as Apple, Coca Cola and Disney. I learnt that with every iPhone sold, with every Coke drunk and with every Marvel movie streamed, these companies make money. And by being a shareholder, I benefit as the money is passed on to me proportionally in the form of dividends.
Without going too deep at this stage (I’ll leave that for later articles in this series), the following are the advantages of investing in shares:
- Returns – Stocks have given one of the highest historical returns among the various asset classes over the long term. The average stock market return is 8% per annum. This is higher than the majority of other asset classes. And on a risk adjusted basis, stocks come out on top over the long term
- Invest in Small Amounts – Gone are the days where only the wealthiest of people with access to top financial advisors could invest money on the stock exchange. The internet has opened up stock market investing to the wider public due to free information, ease of access to markets and low dealing charges. And don’t think these small amounts are too negligible to make a difference, all it takes is £70 a week to become a millionaire.
- Passive investing – Investing in the stock market allows one to be a passive investor. It is the management teams an employees within the companies you invest in that do all the hard work. All you have to do is sit back, relax and let the dividends roll in.
- Income from dividends – Many companies usually distribute a portion of its earnings to its shareholders. If you’re an investor looking for passive income, a dividend-growth strategy can pay off very handsomely.
- Capital Growth – As well as receiving dividends, stock prices appreciate in price over-time as well. Some fast growing companies who opt not to pay out profits in the form of dividends but instead decide to reinvest their profits back into the business see their shares rapidly appreciate in value over time.
- Stocks are easily diversified – You can invest in a number of stocks in different countries, sectors, and industries which gives you various growth opportunities and diversifies your risk. Say you invest in a property and something goes wrong with the place or the tenant defaults on payment, during that period you would not receive income. On the other hand, due to being able to invest in small amounts and the passive nature of the stock market, you can invest in many different companies at once. So even if one company does not declare dividends in a particular year, you can still get income from the other 19 stocks you are invested in.
- Liquidity – Stock are easy to buy and sell. Transactions these days take less than a second to execute. The market is liquid meaning you can turn your shares into cash quickly and with low transaction costs. This is very important especially if you need your money in a hurry.
- Ease of Access – Innovations in technology has lead to the democratisation of the stock market. All you need now is a connection to the internet in order to buy stocks. You can purchase shares through a broker, a financial planner, or online. Once you’ve set up an account, you can buy stocks in minutes.
- Opportunity to invest in markets across the globe – The stock Market gives an opportunity to be a global investor by investing in Shares of companies headquartered overseas. The world is truly your oyster. With property for instance you are restricted to investing within a certain radius of where you live for obvious logistical reasons. If property prices are elevated where you live, you are screwed. Whereas with shares, you are not limited to investing in shares in your own country. You can branch out and buy stocks in well regulated US and European exchanges.
- Tax benefits – There are numerous tax benefits available to investors in the stock market. For one, investing via an ISA allows you to invest completely tax free. That means any dividends you receive or capital gains you make are tax free. Even if you invest outside an ISA, as a UK resident you are able to receive up to £2,000 in dividends tax free.
The above are some of the benefits of investing in the stock market.
Now I don’t want to make it sound like all sunshine and rainbows. Investing in stocks and share is not for everyone. So the following are the drawbacks to investing in the stock market:
- Volatile in the short term – Stock prices can rise or fall sharply because of an overreaction to good or bad news. This volatility makes stocks more risky than something like bonds over the short term. Anyone investing in the stock market has to have the long term view in mind. Whilst stock prices might move at random over the short term, they will almost certainly follow earnings over the long term.
- It can be time consuming – Analysing stocks takes time and effort. You need to be able to understand a company you invest in by studying its financials and competitive environment. You need to be able to follow your company’s developments in the news. Failure to do so could lead you to investing at random. Obviously one can invest in an index fund which requires little time and effort to do. More on index funds later in the series.
(P.S I sell a stock list which provides the names of companies I have researched and I deem to be the best in the world)
- It can be an emotional roller coaster – Stock prices rise and fall second-by-second. The constant availability of prices can cloud judgement and lead investors to buying high, out of greed, and selling low, out of fear. To be a successful stock market investor, one must stay rational at all times. The best thing to do is don’t constantly look at the price fluctuations of stocks, just be sure to check in on a regular basis
So there you have it. I have painted a picture for both sides, for and against stocks.
Looking at the overall picture, I believe that for the small and simple investor, shares are the best investment asset to own over time. And it is not me saying it, the data points to this conclusion as well.
I hope I have answered the question as to why one should invest in stocks. If you are now a believer, so to speak, stay tuned for the next article which explains what a share is.