Author Katrina Shanks, CEO Financial Advice NZ Article originally published on Stuff.co.nz.
Many people will tell you buying shares is one of the best ways of staying ahead of inflation. And that advice is backed by data.
One report shows that in the 120 years between 1900 and 2020 the average annual real return of the New Zealand share market was 6.5 per cent. Another shows inflation was 3.7 per cent a year over a roughly similar period.
I wrote recently one of the keys to investing is staying ahead of the rate of inflation, and those figures show shares, over time, will do just that.
In that article, I looked briefly at the four main places to put your money to protect it from the erosion of inflation – shares, commercial property, cash, and fixed interest.
With that long-term success of shares in mind, and with them grabbing headlines throughout the pandemic, the rise of online investing platforms, and inflation taking off, perhaps you’re tempted to consider them as a place to begin investing. For the purposes of this article, I’m focused on those who’re dabbling or starting out with limited funds rather than investing significant sums.
So, let’s take a deeper look at how they work, how to get started investing in them, and what to be wary of.
But before you start, you need to have a think about your risk – how much money you can afford to lose if things don’t work out and the companies you’re investing in make losses or even collapse.
Risk can be determined by completing a risk profile and is also directly related to when you’re going to need the money you’re investing and where to invest it. Are you approaching retirement or a long way from that? Can you afford to lose money on an investment in the short term?
Like any investment, you should also look at your finances to see what you can afford. Understanding your incomings (wages) and outgoings (living expenses) is key, because once you do that then you know how much you can afford to invest.
How shares work
Companies sell shares in themselves because they want money to finance growth or to invest in innovation, and that’s where you come in.
Shares give you a small stake in a company and in return you get some of its profits by way of dividends and from its growth when you sell the shares.
The price of shares is determined by supply and demand. If a company is doing well because it’s selling lots of its products and making or predicting good results then more people may want to jump on board to take advantage of the higher dividends it may pay, so there’s more demand and so the price of the shares increases.
There are different ways you can invest in shares, depending on your circumstances and risk appetite. You can buy part-shares in many companies on platforms such as Sharesies or Hatch, or in exchange traded funds (EFTs) or managed funds, or you can buy whole shares.
Buying on Sharesies or Hatch or similar is often called micro-investing because you don’t need a lot of money upfront and your risk is usually spread over many companies. It’s a great way to dip your toes in the water with very little risk because you can build a diversified portfolio of investments quite easily.
That also goes for EFTs and managed funds, which are run by fund managers who spread your risk and make decisions for you. Many of these can be accessed on popular platforms as well.
Later, when you’re more confident about how the share market works, you can graduate to bigger amounts in a particular company or companies you like.
But do your homework and study companies to see how they’re performing. Look online at their annual reports and news articles about them, and talk to people who have shares to see what they’re doing.
One of the safest options when first striking out on your own is to look at the so-called blue-chip companies – high-profile ones in growth or high-demand sector that are stable and have a proven track record so are less likely to fail or not perform well.
There’s a lot more work involved for you when doing your own thing. For example, you may need to watch local and world markets to see what’s happening in the industry your company is in, and keep an eye on the share price. It can be very hands-on.
The other key to success is to separate out your casual investing from your plan to build your long-term wealth. Once the value of your investments gets greater or you have more money to invest, it may be a good plan to seek some professional advice.
How much to invest
You don’t have to invest lots, but if you add to it regularly your investment will grow, and with the growth of the company and the growth in their share values you get the benefit of both forms of gains.
One method of investing when starting out is called dollar-cost averaging. This is a great way of minimising your risk.
It works by you investing small amounts regularly into a company’s shares instead of investing a lump sum all at the same price per share. Investing regularly over time decreases and spreads your risk by buying before market prices drop.
You could divide up the money you want to invest into weekly or monthly portions and buy more shares then, no matter what the price is.
Dividing up your purchase in this way maximises your chances of paying a lower average price for the shares over time (remember, we’re talking about a longer-form of investment). It helps you put smaller amounts of your money into the market regularly, meaning you can benefit from market growth well before you would have had a chance to build up a bigger amount. And you will likely end up with more shares for your money and be in a better position than if you had bought all your shares on the same day.
This also works if you don’t have a lump sum but can contribute each payday.
This way can be a good long-term strategy, where you ride the lows and highs of the market while your company grows over time.
This is most effective when markets are on a downward trend but not so much the market is rising. But because shares are a good investment over the long term, that’s not going to matter much anyway.
The golden rules
Like all investments, there is a risk with shares. Here are some rules that will help give you the best chance of growing your money:
- Start investing early.
- Do not invest before you have an emergency fund, because if something happens you may have to sell your shares when the market is low.
- Diversify your portfolio across different companies and industries.
- Be patient – investing is a long game, so be prepared to ride out the lows and wait for the highs.
- If in doubt, get advice from someone with experience in the share market.
I tend to invest small amounts on a platform with funds that are extra to the financial plan which I currently follow. This allows me to have some fun with investments that would not impact my financial future.
In the words of my adviser – you have a plan for the future – stick with it and continue to enjoy your curiosity and passion for different shares and markets which won’t impact your long term goals.