Investors have many investment options available to them, and the option to invest in stocks on the stock market is a popular choice for personal finances. As part of our publication series on investing for beginners, we want to take a look at stocks. In this article, we will address the following topics:
So let's get started.
When you invest money and make an investment in stocks, you become the owner of a part of the company. For example, a company might decide to sell 1 million shares, and you buy 1,000 of those shares on an exchange. This means that you own one thousandth of this company. You have voting rights at the annual general meeting of the Company's shareholders, and you are also entitled to one-thousandth of the Company's distributed profit in the form of a dividend.
People often get confused by the terms stocks and shares. In some ways, these terms are interchangeable. When we talk about investing in stocks, investors usually refer to owning stocks of different companies. When we speak of “shares,” this generally refers to shares or stocks in a particular company.
Companies that are in the start-up or growth stage usually need capital. Lenders, such as banks, are usually only willing to provide this capital to a limited extent. Banks usually charge a high interest rate for these loans. Therefore, shares offer companies an alternative to debt capital.
The sale of company shares brings fresh money to the company, which can be used for its development. While a company pays dividends to shareholders when it makes a profit, it is not required to do so when it makes a loss. With a loan, companies have to pay back the money with interest, whether they make a profit or not. Of course, it is not only companies that benefit from stocks and the equity markets. Investing in stocks helps individual investors build wealth.
When you make an investment in stocks, you become a shareholder and therefore owner of a small part of a company. The advantage is that this allows you to enjoy the full benefits of corporate profits via dividends. But it also means that you accept responsibility for the risks. If the company were to file for insolvency, it would first be the creditors who would get their money back and not the shareholders. This means that you could lose your money invested in stocks.
Let's compare stocks to an investment like a savings account. In a savings account, the bank pays interest at a certain rate on the money in the account. This is called a fixed-income investment because the interest rate remains constant over time. Savings accounts are considered a low-risk investment for your finances because they don't depend on factors like economic downturns that could affect a company's earnings and dividends and change the value of its stock.
However, these fixed-income investments typically offer relatively low yields. Investing in stocks, on the other hand, is a riskier asset class, but tends to offer a relatively higher yield on one's finances (over time). Of course, this remains uncertain and it is known from the past that even broadly diversified stock portfolios can show negative yields over several years.
Many companies pay shareholders a share of their annual profits in the form of dividends. This is a percentage distribution of the total profits.
The shares are sold at a higher price than they were brought.
Heavy losses possible
The price of a share is a result of supply and demand. The price can fall sharply, resulting in losses for shareholders.
No Fixed Yield
Compared to classic investment products (savings account), shares do not promise a fixed yield.
Source: VanEck. The illustration is only intended to provide an overview of the most important risks associated with stocks and cannot replace a complete list of risks. Please contact your financial advisor for more information.
The profit or yield on shares consists of two components – dividends and price gains. The dividend is the part of the profit that the company shares with the shareholders, but not all companies pay a dividend. VanEck offers an equity ETF (exchange-traded equity fund) that invests specifically in companies that pay relatively high dividends, namely the VanEck Morningstar Developed Markets Dividend Leaders UCITS ETF.
Some companies prefer to realise profits and reinvest them in the future growth of the company. With these companies, you realise a capital gain if you can sell shares at a higher price than you originally paid when you invested in the shares. These price gains can occur when the company has increased its profitability, when market sentiment on the stock exchange has improved, or when demand for the shares exceeds supply.
Of course, this also works in reverse, as some companies quite simply generate losses. If a company's earnings decline or market sentiment worsens on the equity market, you may incur a price loss.
No matter what we buy, as consumers we are always looking for the best product at the lowest possible price. When investing in stocks, it can be difficult to determine whether a stock is attractively priced or not. The ratio between the price per share and the earnings per share is often analysed, which is also known as the price-earnings ratio (P/E ratio).
Some financial commentators occasionally claim, roughly speaking, that a share is favourably valued if this ratio is below 15. If it is above 15, on the other hand, the share is considered overpriced. However, this is not always an indicator of how shares will perform.
Shares of Google, Tesla and Amazon, for example, initially appeared overpriced in the first few years as they incurred losses. In the end, however, investing in these stocks proved to be extremely lucrative. In addition, P/E ratios in the European financial sector have been well below 15 in recent years, but this has not necessarily meant higher yields.
This underscores the importance of diversifying the investments in the share portfolio across sectors. Simply put, this means you shouldn't put all your eggs in one basket when you make an investment in stocks.
A stock portfolio is simply a collection of holdings or shares in several companies. When we talk about stock investments, we are basically talking about buying shares. There are other types of investments, for example, bonds, real estate, commodities such as gold, and currencies such as euros or even bitcoin. However, we will address these options in other articles and also how ETFs can be used for the stock portfolio.
Diversifying your stock portfolio is the generally recommended approach. By diversifying, you reduce your risk without necessarily sacrificing yield. If you have invested in many companies and one of the companies becomes insolvent, this hurts less as part of a diversified stock portfolio than if the insolvent company was your only investment.
You can invest in stocks in different ways and in a diversified manner:
If you are inexperienced in finance and the equity market, you are probably wondering how to make an investment in stocks. Generally, you can buy shares of an individual company directly on the stock exchange, or you can choose mutual funds or an exchange-traded fund (equity ETF) for your portfolio. As a rule, the easiest first step is to register with an online broker. You could use the services of a financial advisor within that firm, or you could invest in stocks based on your own research – a combination of both is also possible.
While you can invest in shares of a single company, it is recommended that you also consider mutual funds and equity ETFs, as these types of investments are more diversified. Both types of funds contain several positions and companies, which reduces your overall risk in the stock portfolio. If one of the companies in the fund underperforms, others could improve or remain stable, minimising losses and potentially maximising gains.
Mutual funds and equity ETFs have many things in common. The main differences, however, are how these funds are managed and how they are bought and sold. A mutual fund is typically actively managed by a fund manager, and that manager buys or sells the fund's assets in hopes of maximising profit for investors. Since these funds are actively managed, investors typically pay much higher fees than when investing in ETFs through the equity market.
Equity ETFs are usually passively managed, which means that you as an investor do not have to bear the costs of an active fund manager. Instead, equity ETFs are designed to track specific market indexes, such as the MSCI World, S&P 500, Dow Jones, Nasdaq Composite, Euro STOXX 50, S&P Asia 50 and others. ETFs can also be bought and sold during a trading day on the stock exchange, just as you would when investing in stocks. With mutual funds, you have to wait until the markets close before you can buy or sell. You can also find out more about investing in stocks on the external pages of the online broker 1822direkt and about the stock exchange at Boerse.net.
Advantages and disadvantages of shares in comparison
|Real estate (classic)||
VanEck offers stock ETFs that allow you to build a diversified stock portfolio. All of our equity ETFs invest in a large number of stocks. In addition, we offer many region-focused ETFs that invest in equities in a diversified manner across sectors and regions:
If you expect that a specific sector offers better opportunities for returns than the market as a whole, you can increase your exposure to this sector. VanEck offers ETFs that invest in the following sectors:
Learn more on how you can invest in stocks and get more stock market and financial tips in our Academy course.