Should I be investing in shares?
So you’ve got a bit of extra cash now that you’ve paid off all your debts (bar a mortgage if you have one), set up an emergency fund and taken out appropriate levels of insurance cover. Now what? It might be time to start investing for your savings goal.
I've heard about shares, what are they?
Investing in shares can be an effective strategy for accumulating wealth. When a company is listed on the stock exchange (or ‘floats’ as you might often hear), the company’s capital is divided into individual units, known as shares. Shares are offered for sale as a way of raising additional capital for a company, and when you buy shares in a company you essentially become one of the owners. You don’t have any direct control over the business, unless you buy a LOT of shares, but you’re entitled to a portion of any profits (known as dividends) and to voice your opinion on company matters at the annual general meeting.
Why would I invest in shares?
Studies have shown that shares (or ‘equities’) are one of the best long-term investments in the financial marketplace. They usually outperform other asset classes like cash and fixed interest and sometimes property. Shares are designed to provide investors with two types of return, annual income (through dividends) and long-term capital growth.
But that doesn’t mean there are no downsides. Share prices can go down as well as up, and to get a good return you usually have to lock your money away for at least seven years or sometimes longer.
Shares may be a good option if you don’t have the capital needed to invest in property, and you want your investment to work hard while you save for a goal such as buying your first home.
Here's our take on the pros and cons of investing in shares:
|Good growth potential: Assets like shares usually grow in value and are worth more than what you bought them for. The profit, or gain, is the increase in value of your asset over time. When you sell it any gain you make must be included it in your tax return.||Timeframe: To get a good return from investing in shares, you need to hold them for a long time, at least seven years or more. Even if you held them for one year or 15 years, there’s no guarantee you’ll actually make any profit when they’re sold and might make a loss (which you can use to offset the tax applied to any gains you have made).|
|Low-entry point: Unlike other investment options such as property, shares have a low initial capital expenditure. This means you can buy a few shares (known as a parcel of shares) using a small about of money. For example, you could buy a small parcel of shares with as little as $500 and buy more whenever you have some spare cash.||Risky business: Investing in shares is indeed risky. There are no ‘sure things’ and any broker who promises a ‘guaranteed return’ should be avoided. A company can go bankrupt, leaving your shares worthless, or simply see its share price plummet as a result of economic factors beyond your control.|
|Flexible: Shares are a lot easier and quicker to buy and sell compared to property, for example. You can do this using one of many online trading services available via the internet to help reduce the fees charged on each transaction - or use a broker if you prefer.||Diversification: The popular saying “don’t put all your eggs in one basket” can apply to many things but it applies particularly well to investing in the sharemarket. The sharemarket is one asset class and there are different sectors within the sharemarket you can use to diversify your portfolio - but the amount of money you’d need to do this is probably more than you have to spend.|
|Dividend attraction: To explain this simply, dividends are paid usually twice each year to your chosen bank account by the company whose shares you’ve bought. If a company has paid the full amount of tax we call this a ‘fully-franked’ dividend and if your personal tax rate is higher than the company tax rate, you might have to pay the difference in your tax return. If your tax rate is lower, then you might get a refund for tax the company has already paid. If the company hasn’t paid any tax this is called an ‘unfranked’ dividend and you’ll have to include the whole amount of the dividend in your tax return, paying tax at your personal rate.|
|Tax benefits: Expenses related to investing in shares may be tax deductible. For example, the interest on money you borrow to buy shares. The other consideration is a lower tax on any gains you’ve made if you’ve held the shares for at least one year before you sell them. In this case, your gains are discounted by 50%, effectively halving the amount of tax you would otherwise pay.|
|Have your say: As a shareholder you’re entitled to give your two cents at the company’s annual general meeting. However as there might be thousands of shareholders, your opinion might not carry much weight.|
Where do I buy shares?
You don’t walk into a shop and buy shares the same way you would groceries or an item of clothing. The most common way to buy and sell shares is using a broker or broking service. You can find a broker here or use an online broking service from a major bank, for example. The online services tend to be cheaper as the fees are lower, but you don’t benefit from a broker’s expertise.Other common ways to buy shares include:
- Some companies offer their employees the opportunity to purchase shares in the company. The shares might be offered without a brokerage fee or at a discount to what they are sold on the sharemarket (the ‘market price’). For more information, see employee share schemes.
- Companies may decide to offer new shares to the market as a way of raising capital. This is called a 'float' or an 'initial public offering' (IPO). You don't actually need a broker to buy shares in a float. All you do is send the application form in the prospectus and your cheque to the company.
- Dividend reinvestment plans where you can choose to receive dividends, new shares or a combination of both. These are declining in popularity however and hard to find.
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