Stocks and shares
My ten-year-old son owns Disneyland..!
Well, that’s what he likes to tell his friends at least, and to a degree he is correct.
In fact, he owns units in a worldwide stocks and shares junior ISA fund, which happens to invest in Disneyland, along with many other household names.
So technically he is correct, albeit a more accurate description would be he owns a teeny tiny little slither of Disneyland. Nevertheless, he just loves the idea of owning something special like Disneyland, and looks forward to his equity income funds quarterly dividend distributions.
When you buy stocks and shares, or equities as they are also known, either directly or via a fund, you are buying a tiny stake in a business or company, usually in the hope of an increase in share value, or an income from dividends, or a combination of both.
If the company performs well, it can earn a profit, and you will get a share of those profits distributed to you, usually twice a year, in the form of dividend payments. The value of a successful business is also likely to increase, and that would be reflected in the share price increasing.
If the company doesn’t perform well, there will be no profits to distribute, and the share price and value of your investment may not grow at all, and could even fall in value, meaning you would lose money on that investment.
Individual stocks and shares
Whilst there is nothing wrong with buying individual stocks and shares, and ultimately building your own “home-made” portfolio, it is far easier and less of a risk for beginner investors, to buy either a ready-made and managed fund, or a low-cost index tracker.
The selection of individual stocks is a more advanced strategy, and is beyond the scope of this book. Although suffice to say, one main drawback with individual stock selection is that of putting all your eggs in one basket as it were.
Whilst it is possible to do very well with such a strategy, it is also possible to lose the lot if something unforeseen were to happen.
Funds, sometimes also called mutual funds, and their close relative trusts, are simply ready-made baskets of investments that are created, and managed by a professional fund manager.
This means you don’t have to concern yourself with individual stock picking, or looking after the portfolio, as someone else is doing it for you, albeit for a fee.
Management fees for ready-made portfolios should be less than 1%, although some specialist funds can be higher.
Funds and trusts invest in many different stocks and shares, which is why they are a popular choice for people just starting to invest, as it reduces the risk.
Index tracker funds are simply collective investments that follow the movements of a market index, such as the FTSE 100 or S&P 500.
When an index rises, the value of your fund rises with it, and when the index falls, your investment in the fund also falls with it. Your investment should rise and fall nearly exactly in line with the underlying market index, although there will be some slight difference due to costs being incurred, although such index trackers costs these days, are very low, as they are passively managed.
Passively managed means the fund effectively looks after itself on a day to day basis, usually using technology. It does not need a fund manager making any active investment decisions, hence the much lower running costs.
Low-cost index trackers are very useful for diversifying your portfolio, by spreading your investments over different markets, and countries all at once.
An ETF or Exchange Traded Fund is another type of product that involves a collection of investments, such as stocks and shares, and can also track an underlying index as noted above.
ETFs are similar to funds and trackers, although they are listed on stock exchanges, and trade throughout the day just like ordinary stocks and shares do. This means you would incur a dealing fee each time you bought or sold an ETF, but the ongoing expense costs are usually lower than funds.
ETFs can track all major markets, including stocks, bonds and commodities, and also any mixture of the aforementioned. Some ETFs are even able to benefit from falling markets by going “short”, which means your investment price goes up as the underlying product price goes down. These “short” products are not recommended for new investors.
Growth and income stocks
You will come across the terms “growth stocks” and “income stocks” as you progress throughout your investment journey, and these names are simply another subset or group of the overall stocks and shares universe.
Some commentators think you need to decide what type of investor you are, namely a growth investor, who seeks capital growth from rising share prices, or an income investor, who derives much of their potential returns from income generated by dividend payments.
I don’t think such a decision is needed, there is no rule saying you must be one or the other, and so a combination of both seems to be a good strategy. It’s certainly a strategy I have used and still do.
Investing for income is often seen as the more “steady Eddie” type of investing, possibly even boring to some people, as the strategy involves buying well-developed companies, who are already profitable, and pay good steady dividends year in year out.
They would have decent yields of 4%-6%, (yield being the term used for calculating the dividend distribution over the course of the year, compared to the current share price). Big utility and pharma companies fit firmly into this group.
Any income that is received through your income stocks, should be reinvested, to help boost your overall asset portfolio, and benefit from compound interest of course.
Investing for growth is seen as the more exciting world of investment, and having a much longer-term investment horizon on your side, certainly helps with this strategy.
Growth investments are all about increasing the value of the share price or capital gain. Growth stocks include the likes of Facebook, Amazon and Netflix, who don’t pay much in the way of dividends if anything at all, but their growth is all in their share prices. Some growth companies can increase by more than 100% per year. This would be unusual for a large income generating company.
Yes, another acronym, sorry, but ESG otherwise known as “Environmental, Social and Governance” investing, is becoming very popular and fashionable, and so you should at least know what it’s all about.
ESG refers to a class of investing that is known as “sustainable investing.”
This means that your investment strategy would seek both positive financial returns, and a long term positive impact on society, the environment, and the performance of the business itself. It may include ethical and corporate governance issues, such as managing a company’s carbon footprint, and ensuring there are systems in place to ensure management accountability.
ESG issues that an investor may consider when making an investment could include the following:
Environmental risks – Should you invest in a business that has an actual or potential negative impact on air quality, rivers, oceans, land, or any other ecosystems, or for the potential damage to human health?
Social risks – Would you invest in a business that flouts the health and safety laws of its staff, uses underpaid sweatshops to produce products, abuses human rights, and has no integrity?
Governance risks – Could you invest in a business with a lack of diversity, poor risk management and controls, and excessive executive pay and bonuses?
There are now many funds that cater for ESG investors, and so it is relatively easy to find such a fund, that doesn’t include the likes of, oil producers, arms manufacturers, or other similar businesses.
Whatever type or class of stocks and shares investment you do decide to go with, the first port of call for any such investment is within an ISA wrapper.
Just as a cash ISA shelters your money from the taxman, so does the stocks and shares ISA, which is arguably far more important, due to the potential increases in value that could be made over the years. Look at the investment growth example table again, you wouldn’t want to pay 40% tax on these figures, would you?
This will allow your investments to grow tax-free because you won’t pay any UK income tax or capital gains tax on the returns you make. Nor do you have to declare any income received from an ISA on your tax return as mentioned before.