Shares, Stocks, Equity – What are they? Where do they come from?!

This is the first blog, that will start to look into a building block of Asset Allocation in more detail. This will be exciting series that will cover bonds, equity, alternatives, funds, etc.

Please keep in mind that blog is about investing and not trading. We aim to buy low (or when the price is going down) and sell high (or when the price is going up). Opposite to trading, where you buy when the price increase and sell when the price goes down.

From previous blogs, you may have decided, how much you would like to invest in stock, but before you start, we should understand these a little better.

You may have heard before that when you buy a share, you buy part of the company. Easy to remember, no? Of course, it is a quite small part in the beginning. But why do companies sell their shares? Well,  it is all to do with the capital structure of the company, they do not want to take more debt and could raise funds by offering part of the company to the public. This is also what is called IPS (Initial public offering). Companies’ usually use funds for expansion or paying back some debt. In UK, companies are broadly classed as Limited (Ltd) or Public (PLC). Both can sell shares to investors, but as retail investors, we are interested in PLCs, these companies offer their share via the stock exchange, which is called London Stock Exchange. For the reader, who is not in  UK structures are still very similar.

Let’s have a look at London Stock Exchange. It has two broad groups one is called the main market or primary market. The main market consists of following indices FTSE 100,  FTSE All shares including FTSE 250 and Small Cap. As you may have guessed, companies move between these depending on capitalisation (the share price times the number of shares in issue). This is done quarterly.

The second/secondary market is called Alternative Investment Market or Aim. This market has more forgiving listing rules. As a result, it is more unsafe and risky. Starting investors should be very careful in this territory. Having said that, there are more and more established companies, which are demonstrating a great track record.

Aim stocks are covered by fewer analysts, resulting in the potential mispricing and there are more opportunities to make big. Quite often investor goes to this market to cash in on companies’ growth. However, assumptions, numbers and market prediction not always materialise as expected in the beginning of the period. This means that market comes with higher risk (volatility) and NOT recommended for those who start.

The decision has to be made by you. Prepare your personal IPS/investment objective. If you need higher return, you may need to play with Aim stock. If you do not need huge return and prefer to the safe accumulation of wealth than big companies would be more suitable. Also note that bigger companies more likely to pay sustainable dividends twice a year, Aim usually reinvest profits in growth. In order, to get Div (dividends), you need to own the stock before specified date by the company.

Bid-Ask point and other technical points:

Great! You are pumped, you start learning about stocks you kind of know where you need to invest based on your personal circumstances. You go to the market and you want to find out how much you will have to pay for the company. Interestingly, it will not be the price you see on the screen. This is so called mid point. Between what?!. Bid-Ask or your buy and your sell price. The difference between two prices is called bid-offer spread. For example, if you buy stock A for bid and immediately sell, your loss will be this spread (assuming no transaction cost). The wider the spread less liquid market is and straight from buying you will have higher losses. Thus, you will need a higher return to make sure this is a valuable trade. When you start to look into stocks start with more liquid once. When you become more experienced and knowledgeable, then look into those that have lower liquidity. Remember the first goal of an intelligent investor is NOT TO LOSS MONEY”.

You may remember that you can trade stock via online brokers. Top three broker that you can use, first being the one I use:

  1. AJ Bell YouInvest – www.youinvest.co.uk
  2. Fidelity – www.fidelity.co.uk
  3. Alliance Trust – www.alliancetrustsavings.co.uk

How many shares should you buy or aim to buy to reach good diversification?

Aim to have between 10-20 various stocks. Diversification has little effect over 20 stocks and most likely you have an overly concentrated portfolio under 10 stocks. So you a choice is from 10% – <1%. In the beginning, make it simple, I like 5%. Tend not to invest more than 5% to one asset without good reason. Also remember, that when you start you do not have to spend all your money at once. Spend time investigating potential investment. Think twice before making a purchase.

I would highly suggest employing “Dollar cost averaging” where you invest the same amount every month (or any other period you like) to your chosen investments. This way changes in market prices will have a lower effect on your portfolio and decision making. However, if you decide to use this strategy you should not deviate. In particular, NEVER for HOT issues. Wait for next month get your head straight before buying. Then buy an investment that you have spent time reviewing. Remember monthly changes in prices have a lower impact on overall portfolio performance over long enough time (>10 years).

Remember monthly changes in prices have a lower impact on overall portfolio performance over long enough time (>10 years). Also, you should not invest all of your portfolios in stocks.

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