Equity Investments Guide

Introduction

If you ask anyone what they want the most from their investments, the answer is likely to be: the highest possible return from the smallest possible risk.

The reality is that it is rarely possible to combine the two. There are plenty of ways to save money with little or no risk attached, for example placing your money into a high interest savings account.

But if you want returns higher than the norm, the only way to achieve that is by investing in shares.

What are shares?

Shares, also called equities, are basically the means through which thousands, sometimes hundreds of thousands of people, own individual slices in a company.

That company will be “listed” on a recognized stock exchange, in effect a market where people come to buy and sell shares.

As owners of that company, shareholders benefit from its success – and pay the price for its failures. This means that when you come to buy or sell a share, its price may be higher or lower, depending on its fortunes and that of the wider market.

Sometimes a company may be doing reasonably well but wider economic factors conspire against it. For example, when the 9/11 terrorist attack in New York took place, good and bad companies alike suffered, although the better ones recovered more quickly.

This means the first thing we need to accept about share-based investment is that it can be highly volatile. Demand for a share will drive up its price today, but it may fall tomorrow.

Dividends

Shares also offer the potential to reward investors. This is done by means of dividends, a proportion of company profits usually paid twice a year to all shareholders. A dividend is typically based on a certain sum of money that is paid per share to the person who owns it.

That said, not all shares pay dividends. Some companies reinvest any profits they make and shareholders in those businesses are banking on the fact that the shares themselves will grow in value faster than many others.

Long-term potential

Investing in shares carries risks but it also offers potential. And, historically, shares have justified people’s decision to invest in them.

Each year, a major UK bank carries out an annual study which looks at how shares perform in the long term when compared to other assets. The report is published each summer.

Last year’s report found that in the 20 years to the end of 2005, UK shares produced annual returns after inflation of 6.7 per cent.

This was better than gilts – government bonds – at 6.2% and far superior to cash at 3.9 per cent. Over 50 years, shares have grown in value at 7 per cent a year, compared with only 2 per cent for cash and 2.3 per cent for gilts.

However, it is equally important to note that investing in shares MUST be seen as a long-term strategy, lasting at least 15 or more years. This allows the peaks and troughs in the stock market to even themselves out.

How to invest in shares

Most of us can appreciate this argument and we may even be prepared to accept a certain amount of so-called “equity risk” in order to secure the higher returns that we want.

But we tend to know very little about shares and may be worried about the consequences of buying something that could plummet in value overnight.

Below are four key tips that can help.

Spread your risk

This means owning not just five or 10 different shares but 30 or 40, sometimes many times that. In effect, of the price of one share falls the others should keep the overall portfolio in a healthier state.

This means, by the way, that you should be looking to buy shares not just in different companies or even sectors, like financial or raw materials, but sometimes right across continents. Indeed, there is a powerful school of thought that says shares in different sectors behave differently: some rise and others fall at various times. By holding some of each you minimize overall volatility.

Trust the experts.

Selecting all those shares, monitoring their performance, selling those that are not doing well and buying new ones, all the while researching the market for fresh investment opportunities, is an onerous task. Which is why if you are unsure of what you are doing, it helps to go to a fund manager who will do all that work for you. A manager will usually be investing in anything between 20 and 60-70 shares in his fund. If you are unsure which manager, or even managers, to choose, talk to an independent financial adviser.

Don’t try to 'time' the market

Many investors assume that they need to be in and out of the market, buying and selling feverishly every day. In fact, research has found that over long period of time, it does not matter too much what day, month or even year someone went into the market. After 20 or more years, gains and losses average themselves out.

Drip-feed the market

Clearly, many investors are still likely to be concerned at the possibility that if they stick all their money into shares in one fell swoop, their price may fall the next day – and that has been known to happen. One way round this is to invest smaller lump sums every month.

This is often called “pound cost averaging” and it means that if markets fall, each month you will be buying a progressively larger number of shares with your money. This means that the “average” cost of all the shares you have bought is lower than if you had invested all your money at once. And, assuming the price recovers, your gains will be higher than if you had bought them all at once.

The last word

Finally, and this cannot be repeated too often: if you are unsure of how to invest in shares, do talk to an expert, specifically a financial adviser who is regulated by the Financial Services Authority – the City watchdog – and has all the qualifications necessary to help you make good choices.