Risky business: a guide to (not) buying shares

simon chandler
By Simon Chandler

reports

THE FTSE 100 grew in value by 14.4% in 2016, its best annual performance since 2013 and almost its best since 2009.

Translated into pounds, this means that £232 billion was added to the value of Britain's top 100 publicly traded companies, as more investors bought shares in them despite Brexit and despite fears surrounding the global economy.

Given that the rate of this rise is vastly superior to the interest rates currently being offered by savings accounts and even peer-to-peer lending accounts, it might seem as though the best investment option available to savers is simply that of putting their money into shares.

However, as this guide will make clear, buying shares can often be an incredibly risky business, with the vast majority of investors unlikely to ever "beat the market" and make anything close to 14.4% a year.

The risks

Section menu
What are the risks?
How to get started
Some general pointers
Remaining wary at all times

In fact, over a 20-year period, the FTSE 100 has grown on average by 5.4% a year, yet investors regularly fail to match even this lower rate of return.

For example, studies conducted by financial services firm Dalbar found that the average US equity investor returned -2.28% in 2015, meaning that they lost their clients money.

Likewise, over 20 years, they found that the Standard & Poor's 500 rose by 8.19%, while the portfolio of the average investor climbed by only 4.67%.

Similar findings have been produced by pretty much every comparable survey conducted to date, with stock markets always outperforming professional investors.

If nothing else, this goes to show that shares can't be counted on to yield a reliable return, and that any stockbroker who claims to be able to "beat the market" is either a liar or a madman.

Not only do such brokers consistently fail to match the performance of the stock markets they trade within, but other research has also found that they're often outperformed by savings accounts and bonds.

In July 2016, for instance, the BBC's Paul Lewis conducted a study of the performance of best-buy cash savings accounts as compared to that of the FTSE 100.

He found that the accounts outperformed the stock market in 57% of 192 five-year periods between 1995 and 2015.

Added to this, he also found that when it come to such longer periods of time as 14 and 15 years, savings accounts were the better performer in 96% and 94% of cases.

And if this weren't a clear enough indication of the downsides of shares, the study also found that there was a 25% chance that stocks would lose money in any period of time between one and five years in length. By contrast, the savings accounts never lost any money.

Tips for getting started

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Nonetheless, if this scaremongering isn't enough to put people off investing in shares, there are a few practical pointers they need to consider before starting off on their journey.

1. Purchasing shares online

In the past, shares were bought over the phone and issued on paper certificates, which may have looked nice on the mantelpiece but were often unwieldy and time-consuming for stockbrokers to handle. Today, however, they're bought online, which makes the whole process of being an armchair investor much simpler.

Since they're mostly bought online, this means that potential investors have to visit a "share dealing" website in order to buy them.

Covering such names as Hargreaves Lansdown, Interactive Investor, x-o.co.uk, IG Share Dealing, and TD Direct Investing, these platforms are simple enough to sign up to for customers. However, buyers should bear in mind that they often ask for administration, trade and transfer fees.

Barclays' share-dealing platform, for example, charges a fee of £11.95 for every trade an investor makes, while Lloyds' platform has an annual administration fee of £40.

However, some websites and platforms don't charge monthly or administration fees, while others offer discounts on their trade fees for frequent traders, so it's always worth shopping around for the best deal.

2. Holding shares

Once a share-dealing platform has been joined, and once some potential shares have been targeted, it's necessary for investors to decide how they're going to hold the shares once they've been purchased through the platform.

For the most part, people generally hold their shares through a nominee account, which means that they're registered in the name of their stockbroker or share-dealing platform.

However, despite being under another party's name, they're still legally owned by the buyer, who will continue to exercise full rights over them.

Such rights may include the right to "shareholder perks", which in the case of Marks & Spencer, Euro Disney and Whitbread, for instance, involve discounts on their products.

Given that these discounts can often be worth 10% (in the case of M&S), it's worth making sure that, when you sign up to a nominee account, you'll still have full access to them.

3. Selling shares

But eventually, such perks should be disregarded, since the whole point of buying shares is to sell them once they've risen by enough of an amount for the shareholder to make a decent profit.

Selling them is simple enough, insofar as it simply requires a holder to log into their share-dealing website and sell them on its platform.

Once logged in, it also requires a choice between selling by the number of shares or by a certain value of shares.

Other than that, the only thing to be aware of is that sellers may be liable for capital gains tax, assuming that their gains are worth £11,100 or more. And depending on whether they belong to the basic or higher tax rate, they'll have to pay either 10% or 20%.

One way around this, however, is by giving shares as a gift to a spouse or civil partner (or a charity).

General tips for trading

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So much for the basics of buying and selling shares. However, in addition to practical specifics, there several tips of a more general nature that should also be remembered when entering the stock market for the first time.

1. Invest only what you can afford to lose.

The first is that, when buying shares, individuals should always plan for the possibility that they'll lose money. This doesn't simply mean they should accept losing all the money they invest, but that they should rather decide how much they're willing to see the value of their shares go down by before selling them.

Doing this is important because, the stock market being the stock market, the value of shares will naturally go up and down as a matter of course. Because of this, investors shouldn't start to panic if the value of a particular stock falls within a certain predetermined "safety limit".

However, if the value falls beyond this limit, then they should most likely withdraw their money as soon as possible.

2. Do your homework.

While playing the stock market is occasionally tantamount to gambling, the value of a company and their shares isn't simply a matter of chance. More often than not, it's determined by the performance and expected performance of this company, by how many sales they're making or how much profit they're raking in.

As such, it's always a very wise move for potential shareholders to thoroughly research the company whose shares they're considering.

Not only should they know about sales, revenues and profits, but they should know about the market the company operates in, about economic and political changes likely to affect that market, and about how well the company is doing relative to their competitors.

Good places to obtain information on such matters include financial papers and websites, such as the Financial Times, Citywire, the Motley Fool, and Hargreaves Lansdown.

3. Spread your investments.

Unless someone is buying the shares of company with a license to print money, it's usually a bad idea to buy stock in only one firm.

To take a recent example, if someone had put all their eggs in Toshiba's basket, they would have found that these eggs lost 51% of their value between the end of December and this past January, when the Japanese company revealed it would have to write down the value of a newly acquired American subsidiary.

To avoid such mishaps, it's recommended that investors not only spread their investments between different companies, but also between different industries and business sectors.

4. You can practice with 'virtual' and 'dummy' portfolios

If first-time shareholders feel insecure about taking that initial plunge into buying and selling stocks, they can always try one of the many websites that allow them to simulate trading shares.

In other words, such websites as Investopedia and Virtual Trader enable people to trade "fantasy" shares, without having to spend any money. This permits them to gain a sense of how well they might fare on the actual FTSE 100, yet without assuming any of the usual risk.

However, while such platforms provide newcomers with a sense of how stocks and stock markets can behave, success in them doesn't guarantee any kind of success on an actual stock market.

This is because, shares and markets being as fickle as they are, a company that does well while someone plays a virtual trading game can start doing badly once he or she begins trading for real.

5. Check your portfolio regularly.

This last pointer might sound obvious, but it really is essential that investors check the performance of their shares as regularly as possible.

Not only will this protect them against damaging losses, but it will also put them in a better position to sell up when their shares make suitable profits.

This is because regular monitoring enables investors to gain a clearer sense of the longer term trajectory of their shares, which won't necessarily rise tomorrow just because they've been rising for the previous few weeks.

Buyer beware

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Unfortunately, even with these introductory guidelines and practical tips, buying shares will always carry risk, no matter experienced someone is as a shareholder.

Riskier still are the so-called boiler room scams, which involve a "stockbroking firm" cold-calling an unsuspecting victim with the offer of selling them shares in some promising company.

The thing is, these shares turn out to be worthless, with the victim handing over their money for nothing.

This is why people should be very suspicious if they receive a call out of the blue from people offering to sell them shares.

Yet at the same time, just because they buy actual shares in an actual company, this doesn't mean they shouldn't proceed without caution.

Because, as can be seen with such notable crashes as Enron's in 2001, real shares can also end up being worth next to nothing as well.