You might have heard that investments can make your money work for you, but you’re not entirely sure what investing is. If that sounds familiar, you’ve come to the right place. In this section, we will explain everything you need to know to get you on your way to investing.
If you’re comfortable with the topics on this page, go to Buying Shares
Investing is all about collecting assets. An asset is a valuable thing that can be converted into cash. Most people have personal assets of some kind. If you own the house you live in, a store or a restaurant, things like jewellery that can be sold for money, or even if you’ve lent money to someone, you own an asset!
There are also assets that anybody with some money can own. If you have cash burning a hole in your pocket, you can buy a share in a company, a share of a property or a property company or make loan to a government.
When a company wants to sell shares to the public, it has to go to a marketplace. This marketplace is called a stock market. In South Africa our primary stock market is the JSE (formerly the Johannesburg Stock Exchange). When a company sells shares at the stock market, we call it a public company, because members of the public can own a part of the company.
In this article, we delve into exactly why stock markets exist and how they work.
How do I buy shares at the stock market?
Because thousands of people want to buy and sell shares every day, it’s not practical for each individual to buy and sell shares at the stock market. This is where stockbrokers and financial service providers come in.
Stockbrokers and financial service providers are companies or online platforms that allow you to buy and sell shares on the stock market. These providers have special licenses with the JSE to ensure that they keep adequate records of your transactions. You can only buy and sell shares at the stock market through a broker or financial service provider.
While it sounds very similar, a stock broker is not a person selling you a product like an insurance broker. It’s more like your online banking platform.
Trusting a stockbroker with your hard-earned cash can be scary. The JSE has a list of stock brokers here. However, be careful of platform and brokerage fees, as these can destroy your wealth in the long run (we discuss fees a little later).
As you now know, a stockbroker is a person or a company licensed to buy and sell shares at the stock market on your behalf. In addition to banking services, the majority of South African banks are also stockbrokers. Contacting your bank is often the simplest way to start.
You can usually also find stockbrokers on the website of the local stock exchange. In South Africa our primary stock market – the JSE, has a list of all the stockbrokers in the country. Find the list here.
Much as we would love it, making money from shares is only possible if you have time. As our founder, Simon Brown likes to say, “If you want to get rich quick, marry rich.” The rest of us have to give our money some time to work for us. That happens in one of two ways.
Firstly, you can sell a share for more than you paid for it. Alternatively, you can buy shares that pay out cash payments to you. These payments are called dividends.
Why would I be able to sell a share for more than I paid for it?
When a company is managed well, makes money and grows, its value increases. If other buyers think the company will continue to grow, they want to be part of the success story by owning shares in the company. Because there are only a certain numbers of shares available, other buyers are willing to pay more than you did to get hold of shares. Taking a profit means you sold a share for more than you paid for it.
What are dividends?
A dividend is a cash payment made to you, the shareholder, by the company. When the company makes enough money to pay all its expenses and put money back into the business to help it grow and still has some money left over, that money goes to the shareholders. This article explains how dividends work and how they are paid.
Tip: Read this in-depth article on how shares make money.
Get rich quick schemes are very effective in parting people from their money, because they promise something most people would love: money in a hurry! Who wouldn’t be excited by that? Much as we wish we had a formula for getting rich quickly, we don’t. Your money needs time to work for you. This is because of something called compounding.
What is compounding?
Compounding is when the money you earn, earns more money. That sounds nuts, we know, but it’s a happy reality. Here’s how it works:
Say you open a bank account and deposit R100. The bank agrees to pay you 10% per month for saving your money. After one month, the bank pays you R10 for the R100 you saved. Suddenly you have R110 in your bank account, and you didn’t have to work for the extra R10!
This is already pretty cool, but it gets better. At the end of the second month, the bank once again has to pay you 10%, but this month you have R110 in your account, so instead of R10, the bank has to pay you R11.
Next month you have your original R100, plus the R10 the bank paid in month one, and the R11 you got in month two. That means you have R121 in your account and the bank has to give you 10% for that.
But how does this affect my investment?
Shares are also affected by compounding. Here’s how:
Say you buy a share in your favourite grocery store for R100. While you hold on to that share, the price of the share goes up and down.
When the share price goes up by 10%, your share is worth R110. If you hold on to the share even longer and it goes up another 10%, your share is now worth R121, because the price went up 10% from R110, not R100.
The longer you hold on to a share, the more time the share has to go up in value.
If my money can compound in the bank, why would I buy shares?
While compounding works for money in the bank and for shares, the bank will always try to pay you as little as possible for leaving your money in your bank account. We keep money in the bank to protect it, while we put money in the stock market to grow it. This article explains the difference between saving and investing.
If the price of things you regularly buy, like food and airtime, go up by more than the bank is willing to pay you every year, it means your money can actually buy you less at the end of every year. That’s the opposite of making more money!
The price of shares, on the other hand, go up and down based on how many people want to invest in a company, as we explained in this article. When the company you invested in does well, more people want to invest in that company and the price of the share goes up. As long as the company does well, there is no telling by how much the share price will go up. Your money can keep earning more money for as long as you hold on to your shares.
Now that you have a clear understanding of how investments work, it’s important to understand the risks involved in investing and to know how to protect your wealth from risk.
Unfortunately share investment is not without risk, although this risk is sometimes misunderstood. When we talk about losing money on a share investment, we refer to selling a share at a lower price than we paid for it. Investors often sell shares at a lower price when they need money right away. That’s why a solid financial foundation, including an emergency fund and insurance, should be in place before you make your first share investment. Find out more here.
Sometimes, when we invest in a single company, the share price can fall due to a problem in the company. Just like local businesses sometimes close up shop, public companies can go out of business. If you are a shareholder in a company that has gone out of business, you wouldn’t be able to sell your share to anybody and the value of that share will drop, sometimes to zero. In the stock market this doesn’t happen very often, but it can be quite painful if you have a lot of money invested in a struggling company.
The value of your share can also drop when conditions like the economy, the political situation or natural disasters affect the company. These things happen from time to time and have an impact on how companies do business in the short term.
It is important to work out why the price of your share has dropped. If your share is worth less because the company is struggling or going out of business, you should try to sell your share. If the value of your share is going down because of factors that the company can’t control, like the economy or political situation, your share could go back to its fair value once external conditions have improved. In that case, you should calmly hold on to your share until the share becomes valuable again.
It also makes sense not to invest all your money in a single company. Read more about why you need more than one share here.
How do I know when to sell?
You can sell your share to prevent losing money or to make money.
Hopefully the company you invested in will continue to grow and make money forever. In that case, the value of your share will continue to grow over time. However, if something goes wrong with the company that will prevent it from doing well in future, you can sell your share before the value of the share goes down.
If you sell the share for the same price you paid for it (or more), you don’t lose money. You only lose money if the share price goes down and you sell at a lower price than you paid.
Before you make the decision to sell your share when the price goes down, remember to ask yourself if the price has gone down because something is wrong with the company, or if temporary conditions might be responsible.
You can also sell your share to make money. If the share you own becomes worth much more than you paid for it, you can sell it to another person who is willing to buy it at a higher price. Luckily you don’t have to find another buyer yourself. Your stockbroker will find someone who is willing to pay what the share is worth when you sell it. When you sell your share at a higher price, you end up with more cash in the bank than you had before you bought the share.
If you believe the share you own will continue to grow over time, it’s better to hold on to that share. If the company is paying dividends, you are also earning money from your share as long as you own it.
Can I prevent losing money?
Losing money is sometimes unavoidable, but you can prevent losing all of your investment money by buying shares in more than one company and by choosing companies that do different things.
If you buy shares in four different companies, you can sell a share that is not doing well for less than you paid and still hold on to the three good shares. You can eventually sell the rest of the shares when the share price of each has gone up enough to make back the money you lost on the first share.
However, if you bought shares in four companies that all do the same thing and an external event, like a natural disaster, make it difficult for those companies to do well, all of your shares could lose money. That’s why it’s important to buy shares in companies that do different things.
For example, you can buy a share in a company that supplies groceries to the public, in a company that buys buildings and rents them out, in a company that supplies cleaning services to other companies and in a bank. This is what those fancy investment types mean when they talk about diversifying.
We have good news! If you have R100 per month, you have enough money to invest. Many brokers don’t accept investments under R300 per month, although some accept investments from as little as R50. That means you can invest whatever you can afford.
TIP: Investments should be made for the long run. Here’s a personal finance checklist to make sure that you are ready to invest.
When you decide how much money you want to invest, however, it’s important to keep a close eye on costs. You don’t want fees eating away at your profits.
Why do I have to pay to invest?
Just like your bank account isn’t free, your brokerage account comes with certain costs. In fact, every investment costs money. These amounts may seem small to begin with, but over time they can make your financial goals much harder to reach.
What fees will affect my investments?
A lot of brokers charge an account fee whether you invest or not. This is sometimes called a platform fee and is very similar to banking fees. Thankfully, there are also brokers who don’t take your money simply for having an account. Make sure that you ask how much it will cost to have an account before selecting a broker.
The next fee you will notice is the brokerage fee. This is a percentage of the amount you’re investing that your broker takes for doing the transaction. This, along with the account fee, is how your broker makes money. In South Africa, some brokers charge as little as 0.25% to do your transaction. You have to be satisfied that you are paying your broker as little as possible.
Sadly, this is not yet the end of your payments. Companies that provide investment products like unit trusts and exchange traded funds pass some costs on to you. Total expense ratio (TER) is how much it costs for these companies to manage investment products. This fee includes the price of product management, auditor fees, bank charges, taxes, legal fees and sometimes even marketing fees.
What do fees have to do with how much I can invest?
While you can invest tiny amounts every month, you have to work out how much each transaction is going to cost you. For example, if you invest R50 and the brokerage fee is 0.25%, you will only have R49.58 left over to invest. If you pay an account fee, you have to subtract that amount, as well as the TER. These fees eat away at your investments very quickly.
How do I manage fees if I only have small amounts to invest?
You can still make affordable investments if you only have tiny amounts to invest every month. To begin with, open a bank account to store all of your smaller investments. Get the satisfaction of watching your savings account grow until you have a large enough amount to make a single investment.
I have a lot to invest. What do I do?
If you worry about investing too much, you are very lucky indeed. There is no upper limit on what you can invest. In fact, many brokerages charge less for larger accounts.
TIP: Not sure what you should invest in? We share a few ideas here.