In the recent past, the prices of certain companies have fluctuated significantly. The stock market has also seen a number of new investors trading actively in the secondary market. This article is an attempt to assist investors to understand investment opportunities and risks better.
The stock market provides one of the best opportunities to achieve your long-term goals. It’s straightforward and you don’t need a lot of money to get started. People invest in shares to make money – either through share price growth, or through income paid as dividends.
Capital growth and dividends
Capital growth takes place when the value of your investment increases. People invest in shares because they offer the possibility that the share price will rise. Therefore, owning shares in a company with a rising share price is one way to get capital growth.
As a shareholder, you are entitled to share in the company’s profits or earnings. Companies pay dividends from their net earnings. Dividend payments vary from company to company and it is not compulsory for a company to pay a dividend.
Higher returns over other investments
Although past performance is no indication of future performance, history suggests that Share investments offer higher returns in comparison to other forms of investment over the longer term. However, share transactions also involve a degree of risk, and one needs to be aware of this risk. Speculative trading may increase returns but would also increase risk.
Shares present benefits as well as risks. Though history shows that shares, as a long-term investment and have the potential to provide better returns than any other major investment, it is important to monitor your shares’ performance, and to re-evaluate regularly whether they continue to be a good investment for you. It is important that you identify the risks and take steps to manage them.
nShare prices could fluctuate, meaning that they could move upwards and downwards.
nCompanies do not necessarily have to pay dividends.
nYou may not make the expected return from the investment.
nYou may even make losses.
nHigh profits could also mean high risk. This means that investment decisions would need to be made with care.
nInvesting in companies with strong fundamentals.
I.e. past earnings, future earning potential, dividends declared, business strategy, management acumen, experience of the board of directors, corporate governance practices adopted contribute to fundamentals.
nBy referring Annual Reports, quarterly financial statements published by companies and other information released through the Colombo Stock Exchange (CSE), inform yourself of the potential for returns and the associated risk.
nReading broker research and seeking advice
Research done by stock broking firms on companies and sectors and their performance are a useful source of information for investors. These provide detailed financial analysis, earnings forecasts and share valuations and a host of other information about the company and sector.
nShares are likely to give higher returns in the long-term. Hence, is it best to invest funds that you would not need immediately when investing in stocks.
nBuy shares when the share price is lower than its fair value and sell when the opposite is true.
nDiversify your investments
Spread your investments among the various investment options available to you through the Stock Market
I.e. you can invest in the following
nShares – are likely to give higher returns but also have a higher risk profile
nGovernment Securities – have an almost zero risk and could be more attractive than other saving instruments
nCorporate Debentures – gives lower returns and the risk depends on the risk rating of the company
nInvest within your means. Do not over expose yourself.
nDiversify your share investments by
nNot investing in only one company
nInvesting across many sectors: The CSE has classified listed companies into 20 different business sectors
nSpreading your investment in both shares and debt securities
Tips for investing
nAlways make an informed decision.
nDiversify your investment.
nInvest in companies with sound fundamentals.
nBuy and sell securities at the right time.
nDo not get emotionally attached to a stock.
It is important to keep a realistic view of the stock market. Common myths about the stock market often arise. Below are some of the common myths that are not true:
Stocks that go up must come down
The laws of physics do not apply in the stock market. We’re not trying to tell you that stocks never undergo a correction. The point is that the stock price is a reflection of the company. If you find a great firm run by excellent managers, there is no reason the stock won’t keep on going up.
Stock investing is meant only for the rich
Some people are of the opinion that investing in the stock market is meant only for the large corporates, wealthy investors as well as institutional investors. Many retail investors have a fear of making huge losses in the stock market. However, before you start investing, you should know the basics of stock market investing. This will enable you to maximize your return and reduce chances of committing a mistake considerably and thereby minimize losses. Actually, individuals have an advantage over institutional investors because individuals can afford to be long-term oriented. Individuals have the ability to look beyond temporary downturns in favor of a long-term outlook.
Is investing too risky?
Investing in anything is too risky when you do not know what you are doing. Driving a car is too risky when you don’t know how to control the car and what the rules of the road are. Investing, similarly, is not risky once you understand what you are investing in, and how to go about managing your investments.
Is investing in stocks like gambling?
A share of common stock is ownership in a company. It entitles the holder to a claim on assets as well as a fraction of the profits that the company generates. Most often, investors think of shares as simply a trading vehicle, they forget that shares represent the ownership of a company.
Though there is an element of risk involved with investing, however gambling just transfers money from a loser and gives it to a winner and does not offer growth opportunities, whereas investing provides you and the company you are investing in the opportunity for growth. Therefore, don’t confuse investing and creating wealth with gambling.
Little knowledge is enough to invest in the stock market
Knowing something is generally better than nothing, but it is crucial in the stock market that individual investors have a clear understanding of what they are doing with their money. It’s those investors who really do their homework that succeed.
If you don’t have the time to fully understand what to do with your money, then having an advisor is not a bad thing.
What should you do?
The choice is yours to make long term investments or trade in the short term. One could invest for the long term but one can also make short term investment decisions, depending on the level of risk one can take.
The stock market is more than investing in securities. It is about investing in your future. Remember information is critical. Investing blindly could be risky.