Investing in stocks and shares… Part 2

Investing

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4 best places to invest - Part 2 Stock market

As noted in the last post – investing in yourself is the first place to invest and in my opinion is actually the most important. If you don’t understand the areas you intend to invest in, your investment may return a loss and no one wants to lose money! Once you’ve taken the time to invest in your own education, the next place I would focus on is stocks and shares. This may sound daunting at first, but with the right education, it becomes less overwhelming and you realise that the possibilities are endless!

So, how do I invest in stocks?

There are many ways that you can invest, however for the sake of clarity and concision I will be focusing on:

  • Single company
  • Index funds

Investing in a private/publicly traded company:

You can invest in both large and small companies by buying shares in them – you will own a small portion of the whole company. The benefit of this is that if that company is doing well, the value of your shares goes up.

Once shares are acquired, you can either sell your shares and make a profit off them or hold them and wait until they go up further. In my opinion, it wouldn’t be advisable to sell your shares unless the value of the shares has gone up substantially – even then I wouldn’t sell all my shares in a company that is thriving. 

Some companies pay a dividend and you will get a small return for your money. Different companies pay dividends in different ways and varying amounts – quarterly, annually or biannually.

Dividends are paid out of company profit, therefore if the company is struggling to break even, the dividend will likely be removed.

What should you do with your dividend?

This depends on your age and how much your shares are worth. If your shares are worth over a million and the company pays a 4% dividend, then in theory you should be receiving £40,000 over the year. However, if your shares in the company are not worth much, then you will want to reinvest them. Eventually you will own more shares without having to really add any more money.

You should definitely be adding more money to your investments! Remember the more you invest the more you get back – if the company you’ve chosen continues to do well that is! This is called compounding over time – you are reinvesting the interest and dividends and then they become your total investment. If you want greater understanding of compound interest this explanation by Investopedia below is really helpful: 

SUMMARY – this is a fantastic but risky way to make lots of money over a long period of time. Just make sure you invest in the right company! An important thing to note – well established company’s share prices will be high already.

For this reason many people decide to place their bets on smaller companies in potential emerging markets. If you invest a lot of money into these companies while shares are cheap, then your return if they grow will be amazing! Remember, this is very risky!

Investing in index funds:

Now this method allows you to own shares in many companies that are placed in a single fund. As there are many companies the amount of money you would need to invest in the fund to own a large portion of each would be insane! However, this is not the purpose – the purpose is that if you own a portion of many companies, you are spreading the risk, this is diversification. For example, if I only invest in Tesla and they go bust – I will lose all my money! However, if I invest in a fund and Tesla stock is among them, if Tesla goes bust then I haven’t put all my eggs in one basket.

The fund may take a small hit, as perhaps it invests 2% of all money in Tesla shares. If Tesla have been under-performing, they will likely be removed from the fund and another would be added in its place. This is a much safer and beginner friendly form of investing. Although, just because it is beginner friendly, doesn’t mean that professional investors don’t invest too! 

Warren Buffet is the most successful trader in history and currently 4th Richest man in the world according to Forbs Rich List. Buffet bet $1,000,000 that ‘including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years. The bet pit two basic investing philosophies against each other: passive and active investing’. Buffet is very good at keeping his money! Read the full article on Investopedia – a useful source for investing and building an understanding. 

How do I make money with index funds?

Well if you pick a fund that reinvests its dividends and you consider the above about compound interest this will start to grow. For example, if over a 30 year period you are able to invest £300 per year, you should have amassed £435,346.63. You would have put in £109,000 over the 30-year period. This is assuming you put in a base amount of £1,000 with an average interest yearly of around 8% not including inflation. With inflation at an average of 1.79% you would have invested £142,332.04 and have returned £515,435.39. Click here to see how the S&P 500 and Dow Jones have done since inception. All figures were calculated using a compound interest calculator.

So how do you get that money?

The 4% rule suggests than when your ‘pot’ is big enough, you should be able to live on 4% of the total investment a year until death without fully depleting the fund. Thus how much you will live on each year will depend on your total accumulation.

The same rule would apply to the first method of stocks/shares investing as well. Let’s say you want to live on £40,000 a year. Your investment portfolio would need to be around £1,000,000 when you’re ready to start withdrawing the 4%. A base value of around £1,000 and monthly instalments of £600 with inflation at 1.79% and interest at 8% for the next 30 years would be ideal. Although there is less risk, there is still risk, meaning that if interest rates decrease to 5% you would have needed to invest £1,000 a month to reach that £1,000,000 goal!

Even then it probably would not be possible to withdraw at 4%, so perhaps we would need to diversify our portfolio even more by moving into the 3rd place to invest – but we will save that for next time! If you want more information about the 4% rule.  See the video below about different ideas of how to balance your index portfolio for beginners:

SUMMARY– index funds are a fantastic way to make money over a long period of time that is safer than investing in a single company as your portfolio is diverse. Personally this is my chosen method as I see too much risk with investing in a single company – perhaps in the future with more experience under my belt I will!

How do I start with these two methods?

If you want to invest in a single company, you will need a broker or a broker service – you might have seen a ton of adverts on YouTube about ‘Trading212’ or ‘Plus500’. These different platforms allow you to start investing in individual companies. You could also invest in a hedge fund that has a fund manager (you have to be accredited to invest this way). This is not something I would advise as they usually have high fees as you might have read in the above article from Investopedia

Investment companies such as Vanguard and Hargreaves Lansdown offer a range of mutual funds – these are designed to spread out risk and capture market gains. These are both the cheapest and ‘safest’ of the bunch.  All will have fees, but some are cheaper than others. Personally, I use Vanguard for their ease of use, customer service and lower fees! Not necessarily in that order.

For further information about stocks and shares take a look at this article from the Money Advice Service or check out some of the books listed below. Happy investing – see you next week for option 3.

Glossary

Stocks/shares – Generally, in American English, both words are used interchangeably to refer to financial equities, specifically, securities that denote ownership in a public company.
Dividend – a sum of money paid regularly (typically annually) by a company to its shareholders out of its profits.
Diversification – Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio.
Passive investing – broadly refers to a buy-and-hold portfolio strategy for long-term investment horizons, with minimal trading in the market. Index investing is perhaps the most common form of passive investing.
Active investing – refers to an investment strategy that involves ongoing buying and selling activity by the investor.

Disclaimer – This is not a recommendation to everyone, just what the End-Richs do. If this is something you are interested in, please make sure you do lots of additional research and if necessary, contact a financial adviser.

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