A lot of financial advisors recommend investing in stocks. The 1980s and the 1990s were excellent years for most stock markets. But lately, most stock markets have been struggling. Is it still a good idea to invest in stocks and how should it be done? Here is an introduction to investing in stocks.
Investing in shares is easy and convenient, especially compared to investing in real estate. Nowadays, you can invest in shares using your computer. It has also become much cheaper to buy and sell shares.
You can invest in several different ways in stocks. You can buy shares of individual companies or buy mutual funds. So called derivatives make it possible to make a lot of money with little money but it is also possible to lose a lot of money. Here we are going to focus on investing in individual companies and mutual funds, the most popular ways of investing in stocks.
Mutual funds have become very popular. You give your money to a fund manager who selects what shares to buy. It is very easy but you don’t have any control how your money is being invested. Mutual funds used to be expensive, annual management fees could be several percent. Thanks to index funds, which can be run by computers, you can invest in mutual funds without paying much. It has turned out that funds with high management fees extremely seldom perform better than funds with low fees. Actually, over longer periods of time, like ten years, extremely few fund managers managed to beat cheap index funds.
If you are going to invest in mutual funds, pay attention to the fees. Most funds tend to perform like the index over longer periods of time, before the fees are deducted. This means that expensive funds seldom manage to make up for their higher fees. Nowadays, you should never pay any entry or exit fees. Not long ago, many funds had entry fees as high as 4%. Often part of it was paid as commission to the seller or advisor who got the client to invest in the fund. But funds with entry fees did extremely seldom perform better than funds without entry fees. In most cases, the investor wasted money by paying such fees. If you are going to invest in mutual funds, we recommend cheap index funds.
If you are going to buy shares on your own, you need to do some research. That said, often so called experts have trouble beating portfolios selected by random. There are two main ways of selecting stocks, fundamental analysis and technical analysis.
Technical analysis looks at a stock’s previous performance, typically looking at price and volume. What the company does, how competitive it is, its profits or any other way of trying to estimate a fair price is not of any interest. Instead technical analysts are looking for specific pattern in past price movements, sometimes combined with the volume of traded shares. Specific patterns are identified as sell or buy signals.
Nowadays, technical analysis is easy to do. Computers can quickly process the latest data and suggest what shares to buy. Technical analysis has plenty of supporters but it is very difficult to find rich technical analysts. Many models work for a while but one day they just don’t generate any more profits. You can buy a lot of training and computer programs if you want to try technical analysis. But to us it looks like it is mostly the people selling those products that who are telling you that technical analysis can make you rich.
Fundamental analysis means that you are investigating a company and trying to estimate what the company is really worth. This includes looking at revenue, earnings, assets, liabilities and other figures but also includes judging how good the management is and how tough the competition is. It is a question of finding companies that represent good value, buying them and wait until the price goes up.
Fundamental analysis is far from easy but most successful investors belong to this category. Two terms that are often used are growth investing and value investing. Growth stocks are stocks of companies that are growing quickly, typically the P/E is high while the dividend is very low or non-existing. But as long as the company keeps on growing, the share price generally keeps on increasing. Value investing on the other hand is looking for undervalued companies.