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A little bit about shares

18 Jan 2012 11:22 AM -

If a group of people would like to start a project or build a business venture that requires a large amount of money, the group will form a Listed Public Company and invite members of the general public to become a part of the venture by investing their money in return for shares in that company.

The members of the general public that make an investment into the venture become Shareholders of the company and they are issued with an appropriate number of Shares based on the amount of their investment. The shareholders become part-owners of the company and are therefore able to receive income from any profits that the business venture makes (these are referred to as Dividends) and are also able to benefit from any increased capital growth the company may experience.

Shares are bought and sold on the sharemarket.

Share prices are affected by a number of forces, many of which are constantly shifting. For instance, prices on a single day can be affected by emotional reactions to news of a change in interest rates, inflation, company profits, dividends, economic growth figures, the effects of changes in domestic and international politics and the rise or fall of the dollar.

Just as powerful are the mood swings of investors themselves.

As history tells us, fear and greed can play a significant role in the movement of markets. Time and time again unsustainable market prices, propped up by speculation, have come undone when investment fundamentals and common sense have prevailed.

Here are some common sharemarket myths:

Declining Markets Are The Best Time To Buy

While declining markets usually recover, it can often take time. Some investors see a price drop as an opportunity to buy shares at a discount, while others see it as the start of a deeper downturn.
Predicting the bottom of the market is difficult, if not impossible.

Most investors would be better off staying in the market and using a dollar cost averaging strategy instead of investing all their money at once, they drip feed it into the market so they can average out share prices over time. This has the effect of averaging out market fluctuations over time.

Mis-timing is a huge risk and can often backfire. Investors may miss the rebound completely and have to pay a higher price to get back into the market. They also risk the opportunity of missing out on market growth.

It is important to keep in mind there is no guarantee that share prices will recover to their previous value.

Sometimes, there is a good reason why individual share prices fall, reflecting underlying poor corporate health.

Sell When The Market Drops

Investors with a short-term view of the sharemarket are most likely to sell when the market starts to fall. The fight or flight response is a natural human reaction to panic.

Unfortunately, fleeing the sharemarket when things turn sour crystallizes your losses. It can be costly in terms of transaction costs and capital gains tax - something investors often overlook. It also means you may be out of the market when it rebounds and miss out on future market growth.

With hindsight, many investors who play the game of market timing realise just how much better off they would have been simply riding things out.

And here are some sharemarket truths:

It's Time In The Market, Not Timing The Market

Timing the markets for the best time to invest is easier said than done.

Sharemarkets are unpredictable and if you try to time the market, you have to get not one, but two important decisions right: when to get out and when to get back in.

Intuition tells us that the best time to buy is when prices are down, and the best time to sell is when prices are up. Trying to pick the top and the bottom of the market is not easy and you risk being out of the market when it rebounds. Even professional fund managers find it difficult to continuously time the markets for the right time to invest.

Long-Term Investing Isn't About Chasing The Hottest Performing Stocks.

It's about taking a long-term view and staying the course. It won't protect you from market downturns, but it ensures you are ‘in the market' during times of growth. The best and worst performing asset class can vary from year to year.

One way to reduce your exposure to market volatility is to hold a diversified portfolio of different asset classes (ie cash, bonds, property and shares). Returns from better performing investments can help offset those that underperform.

It’s never too early to invest in your future