Investments >> Equities



There are three definitions of equity -

·      equity - the difference between the market value of a property and the claims held against it

·      equity - the ownership interest of shareholders in a company or corporation

·      equity - fairness: conformity with rules or standards; “the judge recognized the fairness of my claim”

In terms of investment, we are looking at the middle description. Let me describe both the stockmarket today and Exchange Traded Funds, one of the cheapest methods of getting into equities and commodities.

Of all the different long-term investment options open to you nothing, not even property, is likely to make you juicier profits than buying publicly quoted stocks and shares. The UK stock market, for instance, produced an average annual return of 9.6% a year between 1900 and 2005; the US stock market produced 11% a year between 1926 and 1999; and, here at home, from 1974 up to 2006, the annual return averaged 17.4%. These figures relate, of course, to the average annual return. Some investors will have done better than the market, others less well. The key point is, however, that with planning and patience the stock market represents an incredible money making opportunity.

The first question you need to consider is your overall stock market strategy. If you have sufficient capital to buy shares in a range of companies, and if you are interested in participating in the buying and selling decisions, then I would recommend ‘direct’ investment. That is to say buying individual company shares. This has four clear benefits:

1. You will actually own a ‘share’ of the company you are investing in.

2. You will be entitled to a ‘share’ of any profits on a regular basis. This income is known as the ‘dividend’.

3. You can spread your risk – and maximise your gains – by buying shares in a range (or ‘portfolio’) of companies.

4. Your investment is ‘liquid’ – in other words, you can sell some or all of your shares any time you want.

The world’s most successful investor is Warren Buffet, who turned every $10,000 his original investors provided him with in 1957 into more than $400 million today. His advice to private investors is simple: ‘Buy low, sell high, bet big only when you know something the others don’t, avoid popular fads and don’t trade very much as the transaction costs will kill your returns.’ He concedes that it is not an easy formula to follow, especially as we all have a natural urge ‘to get busy’. Buffet is slow to invest in a share – spending years researching a company before making any decision – but once he has bought, he rarely sells.

Studying the tactics of investors like Buffet it is clear that you can dramatically increase your chances of stock market gains by following a number of simple rules.

To begin with, do your homework. Learn everything you can about a company. Look at its annual reports to shareholders (available free), search online for relevant news stories, read up on the sector in which it operates and its competitors. If possible talk to people who work for the company. Bill Mann of motleyfool.com (a website for investors), for example, bought shares in the failing Delta Airlines after chatting with in-flight staff and discovering that they were willing to accept a pay cut to keep the company going. His investment increased in value by 127% in three months! A successful fund manager, Peter Lynch (author of an excellent book called Learn to Earn), says this on the subject of gathering information: ‘Every time you shop in a store, eat a hamburger, or buy new sunglasses, you’re getting valuable input. By browsing around you can see what’s selling and what isn’t. By watching your friends, you know which computers they are buying, which brand of soda they are buying, whether Reeboks are in or out.’ Lynch, incidentally, produced a total return of 2,700% between 1977 and 1990.

Secondly, have clear investment objectives. Are you interested in generating an income? If you are, you should invest in highly profitable companies that follow a policy of declaring generous dividends. Are you interested in long-term capital gain? If you are, you should invest in companies that are more likely to stand the tests of time. You also need to consider what degree of risk you are willing to endure. If a share price goes up you will clearly make money, but if the company does less well than expected or the market as a whole falls, then your investment could be worth less than you paid for it.

Thirdly, remember to diversify. If all your money is one company, or one sector, or one country then you increase your risk. The ideal is to build up a portfolio of shares that meet your objectives and spread your risk.

Fourthly, don’t be tempted to trade too frequently. Whilst share-dealing costs have come down substantially, making it less expensive to buy and sell small quantities of shares, charges can quickly eat into your profits. Also, the more times you buy and sell the less you will actually know about the company you are investing in.

Finally, educate yourself about the stock market and make sure you know how to read the financial pages of the newspapers. At the bottom of this article I have listed some useful sources of information.

If you do decide to invest I would suggest starting with Irish companies.

The Irish Stock Market (one of the oldest in the world and dating back to 1793) offers a good range of opportunities and until the last two years showed steady gains but there are signs of a recovery. The ISEQ Overall (our equivalent to the FTSE All Share Index) stood at 1,000 on 4th January 1988 and recently went through the 8,000 mark – an 800% gain in 18 years!

Do remember, you should discuss your overall financial position with a professional adviser before you start investing in the stock market. He or she will be able to recommend a good stockbroker (the “big five” plus online brokers such as sharewatch.com) and will also help you to avoid paying any unnecessary tax on your gains.

One useful website is the Irish Stock Exchange (http://www.ise.ie) which contains lots of information and tips.

EXCHANGE TRADED FUNDS

What I am about to describe is an investment wolf dressed in sheep’s clothing. Indeed, to most people it appears to be exactly the sort of investment which one might think about if one was having a little trouble sleeping. To dismiss Exchange Traded Funds (aka ETFs) as a soporific, however, is a bad mistake for anyone dreaming of big profits. Because when it comes to a simple, easy, inexpensive method of making your money grow you would be hard pressed to find a better option.

Let’s start by considering some of the problems and dilemmas every private investor faces. To begin with, there is the overriding need to diversify. Depending on your objectives you want your money spread across a range of investments so that whatever happens to interest rates, the economy or the markets your returns are secure. Achieving this if you have a limited amount of money is difficult because you can’t get much of a spread. After all, you need a pretty large amount of capital to diversify properly into – say – property, bonds, commodities, cash and shares. Speaking of shares, the next issue for any investor is how best to benefit from the stock market. Over the medium to long term it is the stock market which produces the most secure returns. Whether you choose the Irish market – which has seen an average 17.4% a year growth over the last 30 + years – or other, international markets – it is publicly quoted shares that are most likely to provide you with consistent gains. The third question you face is that of cost. Whether you are investing in property or buying units in a managed fund, the expenses can be surprisingly high and will eat into your profits. This is particularly true if you are trying to create a portfolio of shares that reflects a particular sector or market. Finally, liquidity has to be considered. Many of the best investments may require time (and effort) to sell.

How, then, can ETFs help? An ETF is nothing more than a basket of assets in a particular market or sector. For instance, it might be a basket of shares in Ireland’s top 20 companies or the leading US commercial property firm. Its purpose is to reflect, as closely as possible, the behaviour of the index, region, country or sector that it represents. ‘Ah ha,’ I expect you are saying to yourself, ‘an ETF is just a fancy name for a tracker fund.’ Well, it is exactly like a tracker fund in that it should give you the same return as the chosen asset class. But there the resemblance ends. Because ETFs have the following unique properties:

-They are actually listed on major stock exchanges across the world. This means you can buy and sell shares in an ETF in the same way as you would in an individual company.

- They are considerably cheaper to buy. There are no upfront charges or annual management fees. A typical managed fund might cost you 3% to buy into and between 1% and 1.5% a year in management fees. A typical ETF will cost you around 0.33% (that’s a third of a cent for every €100 invested) to buy and around 0.50% (that’s less than half a per cent) by way of Total Expenses Ratio (TER). This covers all the expenses of the fund – Administrator fees, Management fees, Custodian fees, Amortised fees etc. Some TERs can be as low as 0.07% ( e.g. QQQ, one of the biggest traded shares in the world because it has billions of dollars in assets under management.)

-They are easy to buy and sell. ETF prices are quoted continuously allowing investors to buy and sell throughout the trading day.

- They are totally transparent. You always know exactly what the underlying assets are and these details are disclosed daily.

-They are secure. ETFs are securities certificates that state the legal right of ownership over part of the fund’s actual assets. In other words, you own the actual assets yourself.

-They can produce an income. Many share based ETFs pass the dividends they receive on to their investors. Investing in an ETF need not mean just capital gain – it can mean an income stream, too.

Investing in Exchange Traded Funds means you can buy actual commodities such as oil and gold without ever taking delivery of oil or carrying an ounce of gold. In fact, name a sector or market and there is bound to be an ETF – or choice of ETFs – covering it.

So, what about performance? Obviously, this mirrors the performance of the underlying assets. If, for instance, you had bought into an ETF run by Barclays called iShares FTSE/Xinhua China Index, which reflects the growth of the leading Chinese public companies, about a year ago you would have enjoyed a return of over 45%. Looking at a different sector, if at the same time you had bought into an ETF called Vanguard REIT Index ETF, which holds property, you would have enjoyed a return of over 35%. Which brings me to another fantastic benefit of investing in ETFs: they allow you to buy into a whole class of assets in one easy step.

The ability to invest in an entire class of assets rather than having to select individual assets reduces risk and boosts returns. It also puts small, private investors on a level playing field with much wealthier investors - because it allows them to develop and control a portfolio containing a broad mix of assets. Now, thanks to ETFs, someone with a few thousand euros can enjoy the sort of average returns and low risk that previously required millions to produce.

How do you pick an ETF? There are ETFs for large companies, small companies, real investment trusts, international stocks, bonds, even gold. Pick an asset class that is publicly available and you’ll find that it is represented by an ETF – or that it will be soon. All the major stock markets have ETFs based on them, for instance. To learn more about ETFs in general visit Yahoo Finance’s ETF Zone (http://finance.yahoo.com/etf). To learn about Ireland’s first ETF – the ISEQ 20 ETF – launched by NCB, visit their web site http://www3.ncbdirect.com  Otherwise, you could talk to your stockbroker, your financial adviser or – of course – please do get in touch with me.

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