Stock markets, stock funds and other kinds of investments can be confusing to the uninitiated. But it is not really as complex as it seems.
Some fundamental knowledge can help with learning to understand investments, and perhaps taking the first steps to investing your money.
What seems to create the most confusion for investors, both beginners and the more experienced, is the difference between stocks and stock funds.
What is a stock?
Stocks give a share of ownership in a particular business. For example, owning a share in Coca Cola means an investor owns a very small part of the Coca Cola business.
If Coca Cola makes a huge profit, the investor gets a share – albeit a small one. The amount is proportional to the number of shares purchased and still held in one’s portfolio.
If the shares are sold before the company distributes its profit, you will not get a share of this bottom-line performance.
On the other hand, if Coca Cola loses money, shareholders are also likely to lose money as the equity price will go down, possibly below the level at which the shares were bought.
There are as many types of stocks to invest in as there are different companies to choose from. These include companies of different sizes – stocks in large companies like Coca Cola (which are known as large cap), mid cap and small cap stocks.
“Cap” is short for capitalisation – the value of shares the company has listed on the market. There is also a choice between stocks in different sectors and industries, such as technology stocks, financial stocks or those from the food and beverage industry such as Coca Cola.
Risks of stocks
Investing in equities can be risky as prices can go up as well as down. There is a risk of losing the entire amount in each equity investment.
For example if an investor buys RM100 worth of Coca Cola shares and if the company ever goes bankrupt, the maximum loss is RM100. This is why it is not a good idea to put all of one’s money into one single equity investment.
To provide variety and diversification to your investment portfolio, an investor could choose to put RM100 each in 20 different stocks.
But often they would have insufficient money available for this to be possible or make it worth their while. Each time a share is bought and sold, a fee is incurred and this can become expensive. Also, having a lot of individual holdings can be more difficult and time-consuming to monitor.
How stock funds work
Given these concerns, a stock fund can be a more practical, effective choice.
How a stock fund works is that a financial institution takes some of the hard work out of investing. It will apply its knowledge, experience and research skills in investing in large amounts in a variety of equities. It manages a large equity portfolio on behalf of a larger group of investors.
By pooling together investor money, stock fund managers benefit from economies of scale – through lower transaction fees, for example. Before handing over any money, research the credentials and style of the stock fund.
Some concentrate on investing in a particular style of equities – such as stocks that pay better dividends. Others might focus on equities from one country or geographic region, or on a particular segment of industry.
The stock fund issues a brochure and publishes a list of its investments to show where it invests. A stock fund may invest in 25 technology stocks from across the globe and, essentially, investors are buying shares in the fund rather than the individual stocks. This means that a RM100 investment in the stock fund gives a smaller share in all 25 tech stocks.
The managers who run the stock fund will have a lot of experience choosing and managing stocks and will better protect your money from market risks. A small fee is charged for their services. However, the benefits of investing in a stock fund far outweigh the costs involved in most cases.
Overall, investing in stocks and stock funds can generate positive returns in the long run. There are risks involved but if you invest your money over the long term, you are likely to see higher returns compared with other types of investments.
This article first appeared in The New Savvy.
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