Question

There has been a lot of talk lately about how shares are cheap at present. I am considering investing in shares but I am not sure how they "work"?

Answer

Stocks and shares can be complex for the first time investor and at the outset I would say that you should not invest money that you cannot afford to loose. Consider the scenario where you invest €5,000 today and in a weeks time it has fallen to €500, if you cannot afford to take such a loss then the stock market is not the place for you.

So what are shares?
Quite simply a share entitles you to a small part of the ownership of a company that you can buy for a certain price on any given day. Share prices move up or down in value depending on the profitability and potential of the individual company, and the overall movement in the stock markets. The aim when buying shares is simple: to invest in companies whose value will increase over time. However be warned that there are highly paid professional investment managers who get it wrong as often as they get it right.

When you buy a share you are entitled to a share in the company profits, known as a dividend. Not all companies are profitable and therefore some do not pay dividends. If you are looking for share investments to provide you with a dividend income the key is to invest in a company which is not only profitable at present but which also has the ability to grow profits in the future.

What are the benefits and risks?
The attraction with shares is the potential to earn a return on your investment from selling shares that have gone up in value since you bought them (capital appreciation) and to benefit from any dividends which the company may pay you (income). Remember, you will have to pay tax on both your sale profits (capital gains tax) and your dividends (income tax). The obvious risk is that your shares fall in value and when you come to sell them you lose some of the money you invested. Be aware that share prices can move very quickly which makes them very risky. It is important to ask yourself if you can afford to take the risk.

So how do you actually invest in shares?
There are several ways in which you can invest in the stock market. Most of the main banks offer stock brokering services, or alternatively you can open an online account with an online brokerage which may be a cheaper option. There are two main types of trading accounts which you can have with a stockbroker. The first is an "execution only account" where you make all the decisions and the broker simply acts on your instruction. The second is an "advisory account" where the broker offers you an opinion and gives advice but you still ultimately make the decision.

Shares in publicly traded companies are bought and sold on the stock market. You can buy individual shares in particular companies. Alternatively you can buy into a basket of shares through what is known as a pooled investment such as a unit linked fund or an exchange traded fund (ETF).

There are costs associated with buying and selling individual shares, namely dealing charges which the stockbroker will impose (ranging from a nominal charge for online brokers to upwards of 3% and a minimum fixed charge for some stock brokers) in addition to government stamp duty (1% on the purchase of Irish shares). These charges mean it is generally not cost effective to invest small amounts in a number of companies - the transaction costs simply eat into any profit made. However, one of the basic principles of investing is not to have all your eggs in the one basket and to diversify as much as possible. Even with small investments you can achieve the benefits of diversification via either a unit linked fund or an exchange traded fund.

Unit linked funds are available through life insurance companies. The funds are managed on your behalf for which you are charged a fee. Normally you will be invested for a set period of 5/6 years so there may be exit charges if you decide to take your money back early.

With an exchange traded fund (ETF) you are buying a share which will track the performance of a basket of shares commonly referred to as an "index", for example the ISEQ 20, an index of the top 20 companies quoted on the Irish Stock Exchange. ETF's are more flexible than unit linked funds as you can buy and sell them as you would shares on the stock exchange. You will pay stock brokers transaction fees when buying and selling but there are no annual management fees or exit charges on encashment as with unit linked funds.

As you can see there are a number of ways of investing in shares and there is a sizable amount of homework to be done before deciding how and which shares to invest in. Investing in shares should be looked on as a longer term investment and your term horizon should be at least 5 years. As always it is advisable to seek professional advice before you invest. And remember shares are not for the faint hearted!

For further information on any of the above contact:
CML Financial, Independent Financial Advisors, The Business Centre, Lisfannon, Buncrana, Co. Donegal, T: +353 (0)74 9364255 F: +353 (0)74 9361955
CML Financial Limited t/a CML Financial is regulated by the Financial Regulator

Joanne Enright MSc QFA MSI
Email: joanne@cmlfinancial.ie