Investors have many different investment opportunities, and the option to invest in stocks is a popular choice. As part of our series on investing for beginners, let’s take a look at stocks. In this article, we will cover:
- What are stocks?
- What are shares?
- Why do stocks exist?
- What are the benefits and risks of stocks?
- What is the return on stocks based on?
- When is a share attractively priced?
- How can you put together your equity portfolio?
- How to buy shares
- Building your equity portfolio with VanEck
Okay, let’s get started.
What are stocks?
When you invest in stocks, you are purchasing a piece of ownership of a company. For instance, a company might decide to sell 1 million shares and you purchase 1,000 of these shares. This means you own 1/1,000 of the company. You will have the right to vote at the company’s annual shareholders' meeting, and you also have a right to 1/1,000 of the company’s distributed profit, which is called a dividend.
- Patricipant: A shareholder is directly impacted by the economic success or failure of a company as one of its part owners.
- High yield: When companies are successful and reap a rich harvest, they make a profit. Shareholders benefit from share price increases.
- Investments: Profits that are not distributed can be used among other things to invest in the future of the business. This also helps to drive future growth.
- Profit-sharing: A company may also distribute some of its profits to the shareholders in the form of dividends. The amount of this dividend is determined at the shareholders' annual meeting, based on a proposal by the Board of Directors and the Supervisory Board.
What are shares?
Often, people are confused by the terms stocks and shares. To a certain extent, these terms are interchangeable. When we talk about “stocks,” investors typically are referring to owning stocks from several different companies. When we talk about “shares,” this usually refers to shares or stocks from a specific company.
Why do stocks exist?
Companies that are just being established or are growing generally need capital. Lenders, such as banks, usually are only willing to loan this capital on a limited basis. Banks tend to charge a high rate of interest for these loans, and stocks offer companies an alternative to depending on loans.
Selling shares of a company generates quick cash for that company, which can be used to help build the business. While a company will have to pay dividends to shareholders if they make a profit, they don’t have to pay a dividend if they sustain a loss. With a loan, they must repay the cash with interest whether or not they make a profit. Of course, stocks and stock markets don’t just benefit companies. Buying stocks helps individual investors build wealth.
What are the benefits and risks of stocks?
As a shareholder, you own a small piece of a company. On the plus side, this means you fully enjoy the profits. However, it also means that you take responsibility for the risks. If the company were to go bankrupt, its creditors would be the first in line to get their money back and not the shareholders. This means you could lose your money.
Let’s compare stocks to an investment such as a savings account. With a savings account, a bank pays a set amount of interest for the money held in that account. This is called a fixed-yield investment because the rate of interest stays the same over time. This is considered a low-risk type of investment because it is not dependent on factors such as economic downturns, which might affect a company’s profits and alter the value of shares.
However, these fixed-yield investments tend to provide a relatively low return on investment. Stocks, on the other hand, while they are a riskier asset class, tend to provide (over time) a relatively higher return on investment. Of course, this remains uncertain and historical information shows that even broadly diversified share portfolios can show negative returns across multiple years.
Source: VanEck. The figure is only intended to provide an overview of the main risks associated with stocks and is not intended to replace a complete list of risks. Please contact your advisor for more information.
What is the return on stocks based on?
The profit, or return, on stocks, consists of two components – dividends and price gain. The dividend is the portion of the profit the company shares with shareholders, but not all companies distribute a dividend. VanEck offers an ETF that specifically invests in companies that pay a relatively high dividend, the VanEck Vectors Morningstar Developed Markets Dividend Leaders UCITS ETF.
Some companies prefer to take profits and reinvest the profits into future growth for the company. With these companies, you realize a price gain if you sell shares for a higher price than what you paid to buy them. These price gains can occur if the company has increased its profitability, improved market sentiment, or if there is more demand for the shares than supply.
Of course, this also works in the opposite direction as some companies simply incur losses. When the profit of a company is reduced or the market sentiment worsens, you can suffer a price loss.
When is a share attractively priced?
No matter what we purchase, consumers are always looking for the best product at the lowest possible price. With shares, it can be difficult to determine whether a share is attractively priced or not. The relationship between price per share and the profit per share often is analysed, which is known as the price-profit ratio.
Some financial commentators might broadly state that if this ratio is less than 15, the share is inexpensive, and if it is above 15, the share is expensive. However, this isn’t always an indicator of how shares will perform.
For instance, in their initial years, Google and Amazon looked expensive as they incurred early losses, yet they ultimately turned out to be very lucrative investments. Additionally, in the past few years, the price-profit ratios in the European financial sector were significantly below 15, which did not necessarily lead to higher returns.
This reinforces the importance of diversifying across various sectors. To put it simply, as the old saying goes, it is not wise to place all of your eggs into one basket.
How can you put together your equity portfolio?
An equity portfolio is simply a collection of investments or shares in multiple companies. When we discuss equity investments, we basically are talking about buying shares. There are other types of investments, such as bonds, real estate, commodities like gold and currencies like Euro or even Bitcoin, but we will discuss those options in other articles.
Diversifying your equity portfolio generally is the recommended approach. By diversifying, you reduce your risk without necessarily sacrificing returns. If you have invested in many companies, and one of the companies goes bankrupt, this hurts less as a component of a diversified portfolio than it would if the bankrupt company was your only investment.
You can diversify in several ways:
- Buy many different shares (i.e., invest in many different companies).
- Buy shares in companies in different sectors (i.e., energy, real estate, health care, utilities, etc.).
- Buy shares in companies in different countries.
How to buy shares
If you are new to investing, you probably are wondering how to invest in stocks. In general, you can directly purchase stocks or shares of a single company or you can opt for mutual funds or exchange-traded funds. Typically, the easiest first step is to sign up with an online brokerage firm. You might enlist the services of a financial advisor within this firm or you might prefer to buy and sell using your own research or perhaps a combination of the two.
While you can purchase stock in a single company, it is recommended that you also consider mutual funds and ETFs, as these are more diversified investments. Both of these fund types will include multiple holdings, or companies, which reduces your overall risk. If one of the companies in the fund underperforms, others might improve or remain steady, to minimize losses and potentially maximize profits.
Mutual funds and ETFs have many similarities, but the main differences include how these funds are managed and how they are bought and sold. A mutual fund usually is actively managed by a fund manager, and this manager will buy or sell the fund’s assets hoping to maximize profits for the investors. Because these funds are actively managed, investors tend to pay much higher fees than you would with an ETF.
ETFs are typically passively managed, which means you don’t have to incur the costs of using a fund manager. Instead, 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 also can be bought and sold during the trading day, just as you would with stocks. With mutual funds, you must wait until the markets close before buying or selling.
Building your equity portfolio with VanEck
VanEck offers equity ETFs that help you build a diverse portfolio. All of our ETFs invest in a large number of shares. Additionally, we have many region-specific ETFs that invest diversely across various sectors and regions: