Investing in Shares - What Kind of Return Should You Expect?
Why would you or anyone else be investing in shares? Find out the most important reasons for investing in shares and remember the most important facts.
The basic idea behind investing in shares is to use your money to make more money. The money you invest in securities is called "capital" and the money created is the "return on investment". With stocks investments the return comes in two forms - capital gain and dividend income. It is well known fact, that on the long term investing in shares is more profitable than any other basic investment.
Capital Gain
Over the longer term, shares can produce significant capital gains through increases in share prices. When investors buy shares, they want the price of those shares in the market to be higher in the future. The higher the future prices, the bigger the capital gain for investors. Capital gain can occur in days or even hours when share prices are volatile, or slowly.
Prices rise for many reasons but most fundamentally they rise because the outlook for a company's future profitability is improving. The biggest and most obtainable capital gains come from the shares of companies that grow and increase their profits over time.
Capital losses occur too, when a company's profitability is declining or its outlook is poor, the share price will probably fall and shareholders lose.
Capital gains become a cash return on investment when investors sell their shares - they get back their capital plus an amount accrued because of the higher selling price.
Dividends
Companies often pay dividends out of their profits. Dividends are a means of sharing the money made by companies with their owners. Just as property owners receive return in the form of rent from their tenants, share owners receive dividends as regular income.
When the amount paid out is high, dividends can be a big part of total investment returns since companies are retaining less money to reinvest in the business to grow potential future profits. On the other hand, some companies pay no dividends and keep profits to help fund growth in their business.
Other Advantages
There are other advantages of investing in shares, compared to other investments. Shares are easy to buy and sell, especially today with increased use of computers; investors can trade on the click of a mouse.
Shares are also very cashable, if you are not speculating on very illiquid shares on the market. They can be sold any time on the stock market and in just few days after the settlement your money can be on your bank account.
Smart Decisions are Crucial
When you decide to invest in shares, making the right decisions is crucial. Your common sense and logic can be just as important in choosing a good share as the advice of any investment expert. While investing in shares, you are actually buying a company. The only reason you buy a share is because the company is making a profit. If you buy a share when the company isn't making a profit, then you're not investing; you're speculating.
A share's price is dependent on the company, which in turn is dependent on its environment, which includes its customer base, its industry, the general economy, and politics. Always have well-reasoned answers to questions such as 'Why are you investing in shares?' and 'Why are you investing in a particular share?' Even if your philosophy is 'buy and hold for the long term', continue to monitor your shares and consider selling them if they're not appreciating or if general economic conditions have changed.
In order to lower risk you will have to diversify your investment portfolio. You should invest in the shares of various companies in the stock market. With sufficient funds you can do this by yourself or you can do it through fund diversification instead. Besides, your investment portfolio should never be 100 per cent of your assets. In case of bear market, shares aren't a good investment at all and therefore it is wise to diversify your portfolio with other investment classes.
Written by: Goran Dolenc
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