Shares and stocks can provide intelligent investors with a financial instrument which yields an income in the form of a dividend and a capital gain through increases in the value of the share price.
Once debt levels have been reduced and a regular savings pattern has been established, it may be time to start looking at how those savings can be best put to work to grow even faster.
Why Invest In Shares?
Often over a long period of time, funds left in bank accounts, even high yielding accounts and term deposits, can lose their purchasing power.
Purchasing power refers to how much a certain sum of money can buy now. Due to the effects of inflation, the same sum of money is likely to be able to buy less in the future - particularly 10 or 15 years in the future. So by leaving funds in a bank account, an income return is received but no capital growth is achieved. Shares and property are two asset classes that offer capital growth.
Property has been a long-time favourite but is also highly illiquid, difficult to pick and requires a significant capital outlay. Shares are liquid assets so if funds are needed in a hurry for any reason, they are easily sold on the stock exchange. The price volatility of both property and shares is high, but the cycles are often much shorter with share prices than property due to the ease of entry and exit of shares.
Share Prices Fluctuate but Usually Make New Highs Eventually
Historically, the value of shares and property rises in the long term, despite several blips such as the Great Depression, several wars, 1987 stock market crash, the Asian financial crisis and the tech wreck along the way.
Another benefit of investing in shares is that smaller amounts can be invested on a regular basis so the risk of not 'picking the right time to invest' is reduced. There are two methods which allow for smaller capital outlays including the use of bought call options and dollar cost averaging.
By using derivatives wisely, smaller outlays can be injected into the market and when the market moves favourably, the investor is then more confident in making the purchase. Bought call options can be viewed like an insurance policy and are therefore very low risk. The most the investor can lose is the amount of the premium which is usually a fraction of what the underlying share value exposure is.
How to Invest in Shares Using Dollar Cost Averaging
By investing smaller amounts in each selected share, on a regular basis, investors will obtain an average price of entry. For example, consider the following table where 19 year old Nathan invested $200 each month in a blue chip company for the last 4 months:
Month 1 - share price $2.24, Nathan purchases 89 units, costing $200 (average cost is $2.24)
Month 2 - share price $2.00, Nathan purchases 100 units, costing $200 (average cost is $2.11)
Month 3 - share price $1.85, Nathan purchases 108 units, costing $200 (average cost is $2.02)
Month 4 - share price $2.05, Nathan purchases 97 units, costing $200 (average cost is $2.03)
So at the time of the last investment, Nathan has invested $800 and paid an average price of $2.03. This is still less than where the market is now at $2.05, which is the aim of dollar cost averaging. Of course this would depend upon price fluctuations, but unrealised losses are minimised, nevertheless.
(Please note that prices are fictitious and brokerage costs are ignored. This example is used to demonstrate the concept of dollar cost averaging only)
Research Prospective Investments
Ensure that detailed research is undertaken prior to investing in the shares and stick to the blue chip companies that have proven their worth for decades. Share investment should be viewed as a long term plan of up to and more than 10 years.
