1.2 The fundamentals


What this topic covers:

  1. Understanding what a share is
  2. Dividend payments
  3. Investing vs. trading
  4. Understanding "the market"
  5. A guide to costs and buying shares
  6. Risks


What is a share?


Companies issue shares to raise money. So, when you buy shares in a company, you’re essentially purchasing a part of that business (FYI, you’ll also hear shares referred to as equities, securities, or stocks). Owning shares gives you the opportunity to benefit financially and grow your investment in two main ways:

  1. Through capital growth where shares can rise in value over time, so you may be able to sell them for more than you bought them for originally.
  2. Through dividends, which we explain below.


What is a dividend?


Dividends are payments made by companies, usually larger, well-established companies, to shareholders from the profits they make. They’re generally paid twice a year but not all companies pay dividends, so they’re not guaranteed. With a 
dividend payment, you get a set amount for every share you own on a particular date. The process looks something like this:



For example, say the dividend for company X was 24c a share, and you owned 1,000 shares in company X. In this instance, you would receive a dividend of $240. 


You can find out more about dividends here.



Investing vs. trading


You’ll often hear the terms “investing/investor” and “trading/trader” used together. However, there are some fundamental differences between the two. Briefly, an investor is someone who buys shares in a company with the goal of growing their investment over time through capital growth. A trader, on the other hand, is someone who buys and sells shares regularly to try and profit from small price changes.


What is “the market” and how does it work?

The stock market brings together buyers and sellers, enabling them to exchange  securities – like shares, bonds, investment trusts, and  exchange traded funds (ETFs). These securities can be listed on a stock exchange (a place to buy and sell) like the New York Stock Exchange (NYSE) or the local share market – the Australian Securities Exchange (ASX). Each company has a stock code – usually three or four letters – which makes them uniquely identifiable and easy to research and trade.



"One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute."

- William Feather (Author of 'The Business of Life')



For decades, stock exchanges were seemingly places of organised chaos with traders often frantically rushing around the trading floor screaming for attention to complete a trade. Even today when most trading is done online, we still associate this image with the stock exchange (incidentally, the NYSE does still have a physical trading floor).


People involved in the stock market range from individuals like you, known as retail investors, to big institutional investors like fund managers, insurance companies, banks, and pension funds.



Then and now: how share trading has evolved.


What are the fees/costs involved in trading shares?


Virtually all brokers charge a
brokerage fee whether they’re old school, taking orders over the phone, or an online trading platform like CommSec. As a general rule, the more you invest, the smaller the brokerage fee as a percentage of your investment. For the latest CommSec brokerage fees, look here


The reason brokerage fees are important is that you need to factor them in when calculating your returns. Here’s an example.


You buy $1,000 worth of shares and sell them a year later.
You pay 2 x $5 brokerage fees (one to buy, one to sell) = 1% of your investment
You’d need to make a total return (through a
capital gain and any dividends) of over 1% before you start to profit.


Frequent trading can also significantly increase your costs, but the longer you stay invested, the less the brokerage fees represent a proportion of your annual returns.


Factoring in brokerage costs to determine overall profit.

 

What are the risks in buying shares?


Buying shares comes with a number of risks and it’s important to understand and be comfortable with them before investing. The biggest risk of investing in shares is that you could lose some or all of your money. It’s important not to trick yourself into thinking that this couldn’t happen to you.


There is the risk that an individual company or broader market – like the Australian share market – doesn’t perform as well as you expected it to, causing your shares to fall in value. Worse still, a company could go out of business and you could lose everything that you invested in it.


Before we go into the specific areas of risk, ask yourself the following questions:


How much can you afford to lose?
Think seriously about how much money you could tolerate losing without it impacting your lifestyle.

Will investing keep you up at night?
Imagine if your portfolio dropped by 10% or 30%. What about 50%? This is the range of falls you should consider in order to find the right balance of investments to match your capacity for losses.

How long do you have to invest?
Your tolerance for risk is connected to the length of time you have to invest. The longer you have to invest, the more you’ll be able to withstand the ups and downs of the share markets'.



Now let's consider the three fundamental risks of share investing:


  1. Capital loss risk. If you sell shares when the price is lower than what you paid for them or even the same price (taking into account your brokerage fees) then you’ll make a capital loss.

  2. Liquidity risk. While most listed companies have many investors who want to buy or sell their shares, you won’t always find a buyer or seller at the price and time you want.

  3. Market and economic risk. Like property and most other investments, companies and the share market are affected by a range of external factors, with some shares more volatile or sensitive to specific factors.


All investment types carry their own risks. Shares are considered a high-risk investment because prices go up and down on a daily basis, so always bear this in mind:


  • The higher the level of return you want, the higher the level of risk
  • The more time you have to invest, the more risk you can afford to take
  • Consider the level of risk across your whole portfolio, not individual investments
  • Don’t invest more than you can afford to lose



Next topic: 1.3 Essential terminology

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Disclaimer

©Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (CommSec) is a wholly owned but non-guaranteed subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945. CommSec is a Market Participant of ASX Limited and Cboe Australia Pty Limited, a Clearing Participant of ASX Clear Pty Limited and a Settlement Participant of ASX Settlement Pty Limited.

The information on this page has been prepared without taking into account your objectives, financial situation or needs. For this reason, any individual should, before acting on this information, consider the appropriateness of the information, having regards to their objectives, financial situation or needs, and, if necessary, seek appropriate professional advice.

CommSec does not give any representation or warranty as to the accuracy, reliability or completeness of any content on this page, including any third party sourced data, nor does it accept liability for any errors or omissions.

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