Don’t shy away from the stock market

 

The stock market can seem intimidating for the inexperienced investor, but it needn’t be. Stocks are the basic units of ownership of a corporation. When you buy shares, you are buying part-ownership in a business. As the company grows, prospers and makes a profit, you could earn a dividend and enjoy capital appreciation. But if the company is not profitable, your shares depreciate in value and you could lose money.

So many people continue to shy away from the stock market, a prominent reason being their fear of incurring losses. They believe that by staying away from the market, they can protect their financial stability. The fact is that there is a significant risk that is so often ignored in forgoing the potential returns on a well-balanced long-term investment portfolio.

For the inexperienced or “lay” investor, a relatively low-risk strategy for investing in the stock market that requires less direct involvement is to invest systematically in a well-chosen mutual fund. This is far easier than direct investments in stocks; a well-chosen equity fund is less risky than individual stock simply because mutual funds invest in several companies, thus spreading the risk. If one company does poorly, the fund as a whole may still have a decent return. If you buy stocks in one company and the company does poorly, you lose money.

A mutual fund pools money from many investors, which a professional fund manager invests on their behalf, typically in a diversified portfolio of stocks, bonds and/or other investments. Unit holders thus enjoy the professional money-management and lower fees and trading costs that are usually the prerogative of substantial investors. By purchasing shares in a mutual fund, you own a piece of the fund, the stocks that it holds, and share in the gains and losses. Mutual fund units are very liquid; shareholders can usually sell their shares at any time, but the price fluctuates daily, depending upon the market value of the securities held by the fund.

A variety of fund portfolios are available to fit varying investment objectives and styles. Some invest for growth in the value of the fund, while others are income-oriented with an emphasis on distributions. Once you have chosen a fund that meets your objectives and comfort level, contact the mutual fund company and request for a prospectus, which has a description of the fund, its investments, and its past performances. All that’s left to do is to complete the form and send in your money.

Consider a simple cost averaging strategy of systematically investing a fixed sum periodically, say monthly or quarterly, in a mutual fund. This is a particularly useful method in a volatile market as you can reduce the average cost of your shares by purchasing more shares when prices are low and fewer shares when they are high. A consistent disciplined approach takes away the speculative element of investing and reduces stress and fear.

As with the old adage, “Don’t put all your eggs in one basket,” don’t put all your money in one stock and don’t invest in stocks exclusively. Try to diversify your investments across different market segments, including real estate, bonds and money market accounts. That way, if one asset class really under-performs, you will have some exposure to other assets.

If an investment sounds too good to be true, it probably is. If an investment advertises 20 per cent in a marketplace in which 12 per cent is the typical return, be cautious. The truth is that for every lucky person, there are many more who have been badly burnt and lost their entire investment where they have been enticed by unusual returns.

Most of us do not have the time or expertise to make our own investment choices without the help of a professional who can work with you to create an investment strategy that suits your unique situation and your risk profile to ensure that the appropriate investments are in place for your changing circumstances.

As you consider stocks, it is important to adopt a long-term strategy rather than looking to make a quick profit. Avoid investing more than you can comfortably afford to be without during your time horizon. It is over the long-term that investors have traditionally reaped the greatest and most consistent rewards, even in spite of the volatility and periods of economic and political uncertainty. Stocks have historically provided a better return over the long term than other investments, but they also carry a greater risk of loss.

In spite of the fact that the stock market will inevitably go through periods of volatility, the superior returns of a carefully executed long-term investment strategy can generally outweigh the risks involved. No investor can afford to ignore the stock market. Indeed, the Nigerian stock market is up by over 38 per cent from the beginning of 2013 till date. In the coming year and beyond, consider including stocks as a fundamental part of your long-term investment strategy.