The Beginners Guide To Investing in Shares

The number 1 question I get asked is how to start investing. It's a simple question but a complicated answer so to help anyone looking to learn how to invest in shares, I have written this blog!

In it, I talk about the fundamentals of stock investing and look at the main investing strategies available to a newbie investor. I also talk about where to buy stocks and what to look out for in quality stocks.

If you're looking for the ideal beginners guide to investing then you've come to the right blog.

1. The Power of Commitment

This is the first thing I teach everyone. Regardless of whether it's people consuming free information or guys paying me $2,000 a day, it's a staple for all investors. I know it's clichéd but dam is it powerful! I'm talking about compound interest. The science of having your earnings make more earnings!

The term itself sounds pretty boring and takes me back to high school math days. So, I'm going to give you some examples that are WAY more interesting!

Millionaire From $2 per day
If you invested $2 everyday and had a return of 15% per year, it would take you 36 years to become a millionaire! Stick with it for just another 5 years and you will have doubled that amount to $2.1m! That's the power of compounding. It took 36 years to get the first million and only 5 years to get the second!

Buffett's Wealth Accumulation
Another great example is Warren Buffett's accumulation of wealth. He became a billionaire at age 56. Only three years later and he had more than doubled this to $3.8bn.

The take-away from this is to invest early and often! A fine lesson for younger people.

2. What Is A Stock?

Before we dive into the good stuff, I want to cover off on what a stock actually is! Very few people provide an explanation. It's just assumed knowledge. Just to clarify, I will use the words stocks and shares interchangeably. They mean the same thing. So, a single stock represents ownership in a company. The more stocks you have, the more ownership you have in that company.

Technically you could buy Apple and own it outright. However it would cost about $750bn. Owning stocks also gives you say on how the company is run. You will be invited to attend the company's Annual General Meeting (AGM) where the board will discuses their strategy moving forward. It is also an opportunity for shareholders to give feedback to the board. Such topics may include executive pay and board member positions.

You Don't Actually Buy Stocks From A Company (Unless it's an IPO)
This is a crazy lesson! It took me a while (slow learner) to get this. When you buy a stock, you aren't actually giving the company your money. You are buying it off another investor or individual. The only time you buy stocks from a company is when they first list on the stock market through an Initial Public Offering (IPO) or if they issue more shares.

I'll explain it in a different way.

Think about trading basketball cards. In 1986, Fleer released a set of basketball cards that included the Michael Jordan Rookie card. Back than you could pick up a pack for $1 and probably a set for $20. Today, A Michael Jordan rookie card in mint condition could go for $100,000+

When you buy the card, the money isn't going to Fleer, the company who produced the card. It's going to the individual (investor) who is re- selling it!

Stocks operate in the exact same way!

3. What Makes Stock Prices Change?

The core thing to remember is that stock prices come down to supply and demand. If a lot of people want to buy a particular stock, then the price was increase. Conversely, if a lot of people want to sell a stock, then the price will go down.

That's why it's key to remember that if you hear about a stock in the media it's too late. That's because the media only talk about popular stocks. Popular in that a lot of people have bought and the price has increased. If you try to buy at this point, you will be getting in at the top. Not a great place in invest.

Common Reasons For Stock Price Changes

1. Good/Poor performance - Companies will have their own internal goals for revenue in a given year. When reporting seasons comes around the stock price will have an almost knee jerk reaction to how the company has performed.

2. Legal Issues  - Think in terms of Facebook and the privacy breaches. The stock has gone from $188 to $133. It can also be a good thing. A pharmaceutical company may have their newest product approved for legal distribution. And of course, pot stocks and the legalization if marijuana

3. Political Issues - Trump imposing tariffs on Chinese imports is a great example. In fact, Trump on Twitter is a great example

4. Company Strategy - At the end of the day you are investing in a company. That means that you need to think like an owner and make investment decisions based on the strategy and FUTURE direction of a company.

The last one is massive. One of my best investments was when QANTAS stocks got hammered and went to $1.10 based on poor performance. The exec team came out and announced a strategy that I believed in.
I exited that investment at $3.50. The QANTAS stock currently trades around $6 per share!

4. Dividend Investing

A popular question from my Masterclass students is how to build a stock portfolio for dividend income.

This can be a powerful strategy where you set up a stock portfolio that produces passive income. So in addition to capital growth, receiving dividend income from stocks is another reason people like to invest. A dividend is simply a portion of earnings that the company is going to pay its shareholders. Think of it as a reward for owning share in that stock.

How It Works:

Dividends work on a per share basis. A company may come out an announce that it will pay share holders a $1 dividend for every share that they own. If you own 100 shares in that company, you will receive $100.

The Dividend Yield
A dividend yield is simply your return expressed as a percentage. It is calculated by dividing the annual dividend by the stock price.

Using the example above you have received $1 per share that you own. If shares are trading at $10 each, than you will be receiving a 10% dividend yield.

$1/$10 = 0.10 or 10%

This can get added to your capital increase (or decrease) to calculate your overall return. If the stock price has increased by 8% per year and you also receive a dividend yield of 7%, you have a total return of 15%.

To receive a dividend payment, you need to be a stock holder in the the company before the ex-dividend date. This date is usually 10 business days before the dividend is paid out to share holders. So you could hold a stock for say 10 months but sell before the ex-dividend date and not receive any dividend for the year.

You could also hold the stock for one day before the ex-dividend date and receive a dividend after only holding the stock for 10 days. I won't go into it here but dividend stripping is a strategy where investors aim to get a dividend payout for holding a stock for a short period of time. Imagine receiving a 7% return on 10 days!

But it's not that easy. Stocks usually trade at a premium equal to the dividend yield before the ex-dividend date. Afterwards, they trade at a reduced amount. Let's say that the stock of a company is trading at $10 per share. They then announce a $1 per share (10%) dividend pay out. You own stocks in this company and it's a Monday. The ex-dividend date is Friday. If you sell your stocks before Friday, you will want to sell for $11 (stock price + potential dividend). If you sell after Friday you will sell for $10 as you have already received the $1 dividend.

There are some cases where you can make money using the dividend stripping strategy, but it's not something that I've attempted to do or have interest in perusing.

5. Active VS Passive Investing

When it comes to buying stocks you have a few different options. You can buy individual stocks yourself through a brokerage exchange. Or you could buy into a fund that essential does the buying and selling for you.

Investing Yourself
This is where you open up an account with a broker of your choice. In Australia, Commsec is a popular option and they require a minimum $500 to get started.  Here you get to choose what shares to buy and sell and at what price. It's all pretty simple once you get involved. In one of my Masterclass program I dedicate a 25 minute video on navigating a brokerage exchange.

Managed Funds
A managed fund is where investors hand over their money to an investment manager who invests on their behalf. People like this option as they don't have to keep on top of the markets all the time. They out source that to a professional.  Managed funds can vary in size and strategy. Some will invest just in US stocks whilst another may just invest in small cap stocks in the Asian market. Some you can get buy into for $1,000 and others may require you to have $100,000.

The key though is to look at the funds performance and fees. Managed funds have a higher fee as you are paying someone else to do the work. The fund will generally take 1%+ to cover costs of managing the fund. They can also take a 20% performance fee if the exceed expectations. If they make $100m profit for the fund, they will keep $20m (bonuses etc) with the other $80m being kept by the fund.

You want to find a fund that has a performance return well above their fees.

Index Fund
An index fund is investing in a fund that tracks the performance of a particular asset/index.

The top 500 companies on the US stock market (often referred to as the S&P 500) is an example of an index. This investment will track the same performance of those 500 companies. The fees are significantly lower compare to managed funds as there is no buying and selling from the fund manager. In fact, the nature of an index fund is that the fund manager can't just buy and sell when they feel like it. It's just tracking a set asset. There are thousands of index funds, all that tracking various assets

Exchange Traded Funds
An exchange traded fund is very similar to an index fund. The main difference being that an index fund can be traded like a stock. Essentially because they are.

Let me explain.

Let's say you have $10,000 to invest and you want to buy each of the top 200 stocks in the US. Your $10,000 wont even get close. Sue is a millionaire and has set up her own company called Sue's ETF. She has enough money to buy 10 shares in the top 200 stocks in the US.

Now as an investor, you can buy shares in Sue's ETF (company) knowing that the performance of Sue's company will mirror the assets (top 200 US stocks) that are owned.

A popular company that specialists in Index Funds and ETFs is Vanguard.

Essentially, this all comes down to active vs passive investing. Do you want to do it yourself? Or do you want someone else to do it for you?

6. Asset Allocation

Asset Allocation is a popular term in the finance world and is one I'm sure you've heard before. It's about spreading your investments across a number of different assets classes that match your risk profile and investing goals.

Find Your Risk Profile
You will lose money investing. It's just that you want to only lose in the short term whilst coming out in front over a longer period of time. Your risk appetite will reflect how you invest. A general rule is that the younger you are, the more risk you can take with your investments because your portfolio has longer to recover.

However, as you near retirement, you may want to be a little more conservative as you don't have as long to recover if the market decreases by 30%. Below is the 4 main assets and their average return from 1985 to 2013.

Every portfolio will have some mix of these assets. It is your risk profile that will dictate how much of each asset you own. This is shown below:

The overall returns increase from left to right. But so does the risk and variance. Aggressive may sound good and it is in the long run, but could you handle seeing your portfolio decrease by 40% in one year?

My core education is around investing in stocks. Once you have chosen your risk appetite and know how much you want to allocate to stocks than you can start building your own stock portfolio.

7. Different Types of Stocks

Not all stocks are created equal. Each one has their own set of risks depending on the business, industry and management team.

Market Capitalization or (Market Cap)
This term gives you a quick snapshot into the size of a company and its valuation. The calculation is just the price per share multiplied by the number of shares the company has issued. A company that has issued 10,000 shares that are trading at $10 each would have a market cap of $100,000

When investing in stocks there are a few types that you can chose from:

Large-cap (Blue Chip) stock: Shares issued by large companies with a market capitalization generally greater than $10 billion.
These stocks are well covered by the media. It's easy to find analysts predictions and forecasts as they are traded frequently. Can generally find a buyer or seller with ease. These are companies with a proven record and business model.

Mid-cap stock: Issued by mid-sized companies with a market cap generally between $2 billion and $10 billion.
These types of stocks can be very profitable for an investor. They've moved out of the small cap area and are really starting to perfect their business model. They are still riskier than blue chip stocks in terms of fluctuation but do have some upside potential.

Small-cap stocks: Represent smaller-sized companies with a market cap of less than $2 billion. These equities tend to have the highest risk due to lower liquidity.
These tend to be more on the speculation side of things. They've yet to establish a constantly profitable business model so make it hard to analyse the numbers. Investing here is about backing what a companies does and if you think its product or service will take off in the market place.

International stocks - Stocks that bought and sold on a foreign stock exchange. This can give great diversification and exposure outside of your home country.

Defensive Stocks - These will be larger companies that not only have a proven business model, but will generate sales during tough economic times. Think of the Coca Cola company. Regardless of what the economy is doing, people are still going to buy Coke. They defend your portfolio in bad times as they generally don't decrease in value as much as other stocks.

Growth (cyclical) Stocks - These are companies that do well when the economy is doing well. They require people to have a disposable income to buy their products. People will be happy to pay $1500 for a MAC laptop when they are fully employed. This purchase becomes less important during tough times when employment may not be as high.

Growth stocks can come from either of the three categories above.

Portfolio Guide
In a good economy, you want to have more growth stocks in your portfolio so you can take advantage of their price increase

In a struggling economy, you would want to have more defensive stocks as to protect your portfolio.

Your portfolio should also have both and should always reflect the economy.

8. Analysing Stocks

When analysing stocks to invest in you have two broad approaches. Fundamental and Technical Analysis. I teach these extensively in my Masterclass as they are the essence of stock analysis.

Here I cover the basics to get you started:

Fundamental Analysis
Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a stock. Fundamental analysts study everything from the overall economy and industry conditions to the financial condition and management of companies. Earnings, expenses, assets and liabilities are all important characteristics to fundamental analysts. This approach is used by Warren Buffett. He determines the intrinsic value of a company and purchases stocks in that company is they are trading below this number. This is the essence of value investing.

Technical Analysis

Technical analysts do not attempt to measure a security's intrinsic value, but instead use stock charts to identify patterns and trends that suggest what a stock will do in the future. The most popular forms of technical analysis are simple moving averages, support and resistance, trend lines and momentum-based indicators.

What Next?

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