Shares are much simpler than they first appear
Shares may entitle you to a share of the profits of a company (dividends) or give you voting rights.
There are two main ways you can benefit from share ownership:
- if the price rises and you sell
- if the company pays out a portion of its profits as a dividend
You can buy shares directly from the company or through a financial institution.
You can also own shares by buying funds (mutual funds or index funds). This can be better for individual investors because it provides diversification. Owning just one or two companies is quite risky, as they could suffer losses or go bankrupt. Owning shares in tens or hundreds of companies is difficult for investors, particularly when they are starting out.
By buying a fund you can own a piece of hundreds or thousands of companies without having to buy individual shares.
Funds are either active (they have a manager who decides what shares to buy) or passive (they automatically buy shares based on a base model such as an index like the S&P500 in the US or the TOPIX in Japan).
Mutual funds are provided by a financial institution and exchange traded funds (ETFs) are bought and sold like stocks.
There are four main approaches to investing in shares:
- dividend (yield) investing
- value investing
- passive investing
That list is in order of difficulty (most difficult first) and in reverse order of effectiveness (most effective last). The easiest method is also the most effective over the long-term.
We'll look at each of these in turn in the next few posts.