As we’ve discussed before, share investing is not without risk. Most new investors are scared of losing all their money, but that’s not very likely in share investing. The type of risk we’re referring to is like death by a thousand papercuts.
In the short term, share prices are determined by buyers and sellers. If there are many shares in one company and few people to buy them, they will be cheap. If there are few shares and many buyers, they will be expensive. Most large shares see their prices go up and down constantly during the course of a day, because there are always people buying and selling. If a share is very popular, its price can be different at the end of each day. The word for prices that go up and down all the time is “volatility”. This is the big risk in investing.
Volatility doesn’t sound scary
Prices that go up and down a lot doesn’t seem all that bad, right? If you only have a few shares, it’s no big deal. However, once your share collection starts to grow, selling at a lower price can cause real damage.
For example, if you have 50 shares that each lose R1 in value, you lose R50. That’s baby money. If, however, you have 5,000 shares that each lose R1 in value, you lose R5,000. That can put food on the table for a few months. Imagine what would happen once you had 50,000 shares or if your 5,000 shares lost R5 each.
Volatility is risky, because a share price might be down on the day you need to sell. You’re not likely to lose 100% of your money, but you might have to sell when the price is down. You have two defenses against this risk: time and variety.
Let’s say you saved for your next holiday by putting money in the stock market. On the day you need to buy your ticket, the shares you bought are all R1 down. You only really lose money when you sell. Unfortunately you need the money today or you can’t go on holiday. You can’t wait for the share price to go back up to where it was when you bought it and you become a forced seller.
However, if you leave your holiday money safely in a savings account and use your share investments to save for retirement, you only need to sell your shares when you feel like it. If a share’s price goes up a lot, you could sell it to make a profit or you could leave it indefinitely to see how high it will go. If a share’s price goes down, you have enough time to wait for it to get back to where you bought it before you decide what to do. Time eliminates a lot of your investment risk.
A portfolio is a fancy term for all the assets we own.It includes shares, money in bank accounts, houses, our retirement savings, tax-free savings and anything else that can earn us money in the long run.
When your portfolio has only one thing in it, your future depends on how that thing behaves. For example, if you used all of your money to buy just one share and the share’s price goes down by 20%, you will immediately have 20% less than you started with. For that reason, the first type of variety you want to introduce is in your portfolio. It’s not a good idea to have just one type of asset. This is another reason why it’s very important to have your financial foundation in place.
You can also protect your money against volatility by buying many different shares. Investing in a single company means your lot is cast with that company, no matter what. If the company’s share price goes down 20%, so will your whole portfolio. If you’ve invested in more than one company, you can rest assured that some share prices will go up, even if some shares do badly. Your overall portfolio will move around a lot less as a result.
Next it’s time to look at industries. Mining companies require different conditions to do well than banks, which in turn require different conditions than technology companies. No one industry is better than the other. Instead, different industries thrive at different times, which is exactly why you want to make sure your investment is spread out across different sectors.
Lastly you don’t want to be exposed to just one economy. Sometimes different parts of the world do better financially than others. It’s a good idea to have investments in different regions across the world to bring stability to your portfolio. For that reason it pays to have some money locally, some in America and some in Europe.
Choosing the right share in the right industry in the right country can be a full-time job. Luckily those of us who aren’t interested in filtering through hundreds of shares can get a portfolio of shares with variety built in. Index-tracking products are financial products that buy a variety of shares, package them together and sell them all in one go. Find one suited to your financial goals here.
Being outstanding with your money doesn’t have to be hard. This series of articles will give you all the tools you need to get your house in order to start investing. Written by Just One Lap and sponsored by OUTvest, this series is the ultimate guide to outstanding money.