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.
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, we have only one stock market, called 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.
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 only stock exchange, 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 prevent losing 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 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.
TIP: Not entirely sure what a broker is? We explain it all here.
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.
Now that you understand what shares are, how the stock market works and where stock brokers fit in, you are ready to learn about selecting shares, different types of shares and the wonder of diversification.
Selecting your first share is quite terrifying. It becomes even more daunting when you tell people about it. Before acting on a hot tip from a family member, ask yourself why the person giving you advice hasn’t made a fortune buying that share themselves. Then ignore it.
Selecting a share is about educating yourself and trusting your own judgement. Start with these four steps:
- Buy companies you understand. Before you buy a share, ask yourself if you know how the company makes money.
- Buy companies that have been around for a long time. Can you remember if that company was around when you were a kid? Do a quick online search to find out about the history of a company. This rule of thumb doesn’t mean new companies are always bad investments, but it should help you think about whether a company has what it takes to be around for a lifetime.
- Don’t buy companies that all do the same thing. If some external event only affects a certain type of company, all of your shares could lose money at the same time.
- Don’t confuse your experience with a company with how the company is run. It is possible to have a bad experience with an employee of a great company. Instead, ask yourself if you understand how the company makes money.
You already know what a share is. You also understand that you can invest in ordinary shares, in property and in bonds. You understand that investing your money in different companies and different types of shares will better protect your money.
If this all makes sense to you, take a moment to congratulate yourself. It’s a big deal! By now, you are probably wondering how on earth to select the right companies and bonds. There are so many options available. If you’re just starting out, it can be overwhelming.
Thankfully there are things called collective investment schemes (CIS) to help you.
What is a collective investment scheme?
Collective investment schemes are a lot like cakes. To bake a cake, you need a few ingredients – flour, sugar, eggs, milk and baking powder. When you add all of those ingredients together and bake them, only one delicious cake comes out of the oven. Most of us don’t eat a whole cake in one sitting, so we buy a slice (or two) of the cake to enjoy.
Collective investment schemes are also made up of ingredients – shares in different companies, property shares, bonds and cash. All of those ingredients are baked into a product. As an investor, you buy a slice of the product, which is called a unit or a share.
When you eat a slice of cake, you are actually eating five different ingredients. When you buy a unit or a share in a collective investment scheme, you are actually buying all the different ingredients that make up that product.
So what exactly can I buy?
There are different types of collective investment schemes, but our favourites are:
- Unit trusts; and
- Exchange traded funds (ETFs).
What are unit trusts?
Different types of assets can be put into a special kind of account, called a trust. Unlike normal bank accounts, trust accounts are managed by a designated person or company, called a trustee. A lot of the time, more than one person benefits from trust. A person benefiting from a trust is called a beneficiary.
A unit trust is a type of collective investment scheme. The account has the type of assets ordinary people would like to invest in. For example, a trust can be made up of shares in different companies, shares in property companies and some bonds. It can even have some cash in the bank. The trustee decides which companies to invest in and how much of each type of asset should be in the trust. The trust then buys all of those assets and stores them in the account.
You can become a beneficiary of the trust by buying one or more slices of the trust. In this case, the slices are called units. Just like buying a slice of cake actually gets you some egg, flour, milk and baking powder, buying a unit in a unit trust gets you some of all the shares, property, bonds and cash held by the trust.
Not everybody likes chocolate cake. Some people prefer carrot cake, and others like lemon meringue. Similarly, not everybody wants the same type of investment. Some people might prefer to own a lot of shares, but only a few bonds. Others might worry about having too many shares and would feel safer having some cash. You can choose a unit trust that holds the type of assets that you prefer.
What is an index?
An index is a way of tracking the performance of a group of companies on an exchange. It’s normally graph representing the share price of a particular group of companies. The graph goes up or down based on the average share price moves of these companies. The index is just a representation of the prices of the companies it’s tracking, it doesn’t hold any investments.
It’s so easy that you can even make your own index. Think of companies where you regularly shop that are listed on the exchange. At the end of every day, find the share price of all those companies on Google. Add all the prices together and place a dot on a graph that represents that amount. You’ll soon notice that some days the dot is higher than the previous day, and some days it’s lower, depending on the share prices of all those companies. Cool, eh?
In South Africa, the most popular index is the Top 40 index. This index tracks the 40 biggest companies on the JSE.
What does an index have to do with collective investment schemes?
Now that you know what an index is, we can look at another type of collective investment scheme called an exchange traded fund (ETF).
An exchange traded fund is a type of product that buys shares in all of the companies in an index. If an index tracks five car companies, a company can make a product by buying shares in each of those five companies and then selling slices of that product to the public.
When the five companies do well, the index goes up and the ETF does well. If the car industry struggles and the companies don’t make money, index goes down and so does the ETF.
Who makes ETFs?
Banks and other financial institutions make ETFs. The ETF products then lists on the exchange, just like a company. Investors like us can buy the ETF products through brokers. You can read more about different ETFs and how they work here.
You’ve probably been discouraged from putting all your eggs in one basket at some point in your life. While we abhor the cliché, we can’t argue with the logic. When it comes to your money, it’s a very good idea not to put everything in once place. On your investment journey, you will hear the word “diversification” regularly. In this article we will explain what diversification is and offer a few thoughts on how to achieve it.
When should I diversify?
Different types of savings and investments do different things. Having money in the bank protects your money against bad events that happen to shareholders. Buying shares helps you earn more money than if you left all your savings in the bank. Buying a second property or property shares helps your money grow even when external events affect the stock market.
When you plan your financial future, you should cover as many bases as possible. Some of your money should be in the bank in the form of an emergency fund. You should use some of your money to buy shares and some of your money to invest in property.
When you invest in shares, you can diversify even further by ensuring you don’t invest all your money in the same company.
Why can’t I put all my money in one place?
When you buy a share in a company, you assume that the company will continue to do good business for a long time. If the company does good business over time, your share price will go up and you will make money.
Unfortunately there aren’t any guarantees when it comes to investing. Things do go wrong with companies sometimes. The market might turn, companies can be mismanaged or customers might no longer want a company’s product. In any of these events, the company’s share price could go down to below what you paid for a share. If you sell your shares at a lower price, you will end up with less money than you had before you bought the share. Your investment would have lost money. This is what people mean when they talk about investment risk.
If you used all the money you had to buy shares in only one company and that company’s share price dropped dramatically, you would be in a worse financial position than you were before you bought the shares. In that case, you would have been better off just leaving your money in the bank.
How can I protect my money?
Fortunately, you can protect your money when buying shares by investing in different industries, companies and products.
Why do I need to invest in different industries?
Companies are affected by things that happen in the world. For example, if there are floods in an area of the world that produces rice, companies that make rice-based products will likely be affected by the event. An event like this can cause the company to earn less money in a year. When a company makes less money, many investors will want to sell their shares in that company, which will bring the share price down.
However, a company that produces spare parts for luxury cars will probably not be affected by the floods. Those companies will still earn money and won’t have to worry about the price of rice.
When we refer to industries, we mean businesses that all do the same type of work. For example, your favourite grocery store is in the fast moving consumer goods industry, while your bank belongs to the banking industry. A flood is more likely to affect your grocery store than your bank, while a global financial crisis will probably affect your bank.
When you start thinking about which shares to buy, choosing companies that do different things will protect your money against events beyond the control of those companies.
Why do I need to invest in different companies?
The first reason to buy different companies is to ensure that you are invested in different industries, as we’ve already discussed. However, you might want to own shares in two grocery store companies and two banks. This is a good idea to protect your money against things that can go wrong within a company.
Have you ever read a negative story about a company in the news? Perhaps something was wrong with the product the company produced or perhaps management were stealing money from the company. Events like these do occur from time to time. When a company is in the news for all the wrong reasons, shareholders want to get rid of their shares very quickly. Once again the share price of that company will drop, even though the news event doesn’t affect the whole industry.
If you bought shares in two grocery companies and one is in the news for all the wrong reasons, your shares in the other grocery company will continue to make money.
You’ve already come a long way in understanding the world of investments. In case you missed it, we explain all the basics in our article on how investing works here.
There are different types of shares that do different things for investors. In addition to shares in public companies, you can also buy shares in property or property companies.
What is property?
Property can refer to an empty piece of land or to a building and the land on which it stands.
What does investing in property mean?
When people talk about investing in property, they mean they buy shares from a company that either:
- Owns buildings and rents it out to tenants; or
- Develops and sells property.
People like to invest in property companies that rent out property, because that rental income is shared among investors, just like dividends in a normal company. Think of it as owning a house and renting out the rooms. Property companies are alluring to people who need regular cash payments, for example retirees who no longer earn a salary.
Companies that buy empty plots of land in order to build new houses, apartments, offices or shopping centres are called development companies. Investors like these companies, because they often earn a lot of money in a short time by selling these properties once the buildings are complete.
Some property companies buy empty plots of land, build buildings on the empty land and then rent out the buildings.
How do I invest in property?
Just like any other type of company, larger property companies are public companies, which means they are listed on an exchange. In South Africa, we only have one exchange, called the JSE. Just like investing in any other public company, you can buy shares in property companies through a broker.
You can also buy groups of property companies by investing in a property ETF.
Isn’t it strange that debt can be an investment? Unfortunately we don’t mean the kind of debt that gets you the latest threads. It’s actually more accurate to say lending money to someone else can be an investment.
How can debt be an investment?
When you borrow money from the bank, you don’t only pay back the amount you borrowed. In exchange for giving you the money when you need it, the bank charges a fee and interest. That is how the bank makes money.
If you lend money to your friend, you can ask them to pay you a small fee for every month they don’t pay you back. When they do pay you back, you get the original amount they borrowed, as well as that fee. Your money earned more money, which makes it an investment!
What does this have to do with shares?
There is a special type of share that companies or the government sell when they want to borrow money. When the government wants to borrow money, these are called bonds. If it’s a company borrowing money, the shares are called corporate bonds or preference shares.
How are bonds different from shares?
As we already discussed, the price of a share changes depending on how well the company is doing. If you bought a really good share, the price can go up over time and you can eventually sell it for more than you paid for it. You can also earn dividends on a share.
Bonds are more like lending money to a friend. The company or government that sells this certificate tells you when they will pay you back and what fee they are willing to pay to borrow money from you. The fees are usually paid out to you in intervals over the loan period, for example every three months until you get back the full amount they borrowed.
Why would I want to buy a bond?
Bonds are considered a safe investment, because you know that you are very likely to receive back your original loan, as well as the fee for lending the money. If something goes wrong with a company that borrowed money from you, the company is required by law to pay you back before worrying about shareholders who bought ordinary shares.
While you are protected if something goes wrong, you don’t benefit when things go well either. You will always only receive the amount you agreed to when you bought the bond, even if the company’s ordinary share price goes up.
Bonds are a good investment for people who want to take very little risk, but still want to earn some money.
What does the government have to do with it?
Just like people and companies, governments all around the world borrow money from their citizens. Unlike companies, governments are very unlikely to go out of business (and if they do, you have bigger problems than your investments). Governments can issue bonds through the exchange, just like companies, or they can issue bonds directly to the public. In South Africa, you can buy Retail Savings Bonds directly from the National Treasury or the South African Post Office.