EQUITIES – VERY popular with some, much maligned by others. A get-rich-quick tool or a lose-money-quick tool? Is investing in the stockmarket wise … or foolish? Debating the pros and cons of equity investment is as popular as ever and many people have quite firm opinions on the subject, but it doesn’t mean they are right.
While the only tool that would guarantee the absolute success of equity investment is a crystal ball, there are plenty of steps you can take to reduce risk at the same time as increasing the likelihood of above average returns. By taking these steps, equity investment is usually rewarding and worthwhile.
The most important things to remember when considering equity investment are:
1.It is time in the market, not timing,
that counts
2. Thorough diversification is
essential
3. Use experts to manage your portfolio
What is equity?
If you own equity, you own part of a company. They are also known as ‘shares’. Companies that are quoted on the stockmarket may be owned by thousands of investors, either directly or through equity funds. If the company does well, the value of your shares should go up. If it does badly, share prices will fall.
Some equities provide an income from dividends. Often, if you buy an equity fund, the dividends are reinvested into the fund, providing increased growth. The ups and downs in the value of equities are greater than for bonds, and equities are a higher risk investment. In return for the higher risk comes the probability of greater returns generally available from bonds or cash over the longer term.
The current market
Many experts had predicted a quiet year for shares in 2005, but it has turned out to be more exciting and profitable. In early October, the FTSE 100 hit 5,500 – a gain of 14 per cent since the start of the year (and before you include dividends). Fortunes then changed and the index fell to 5,142. However, it has since climbed back up and, at the time of writing, stands at 5,480. The FTSE 250 has just traded at over 8,000 for the first time ever.
Many experts pinned the blame for the October dip on profit taking by institutions cashing in on market gains and said the market should get back on its feet relatively soon – which appears to be what is happening. In as far as it is ever possible to predict stock markets, the future looks encouraging.
Valuation measures like the P/E ratio suggest that shares are still cheap and, therefore, capable of further increases. Merger and acquisition activity has picked up substantially. A recent survey found that European companies expect to improve their margins and pricing power in 2006, which is good news for equity markets. The US third quarter gross domestic product numbers were stronger than expected, helping boost markets, and more investors are shifting into equities.
Protecting your future
None of this matters if you don’t invest sensibly and plan for both upsides and downsides. Chasing ‘hot stocks’ or buying recommendations from friends is unwise. You are likely to end up making choices that are outdated, misguided or inappropriate for you. An investment is a commitment for your future and you should do everything possible to protect it.
The first step is to accept that you should not be trying to get rich quick. To quote an article I read recently, “the market saves its greatest rewards for the most patient investors. Investing in shares … does provide a slow and steady path to wealth.”
First of all, you need to invest for the long term, for example, at least five years. Over time, stock market peaks and troughs get ironed out into a simpler, upward climb. Secondly, you need to own as many different shares as possible. If one share falls, the rise in other shares will cancel the loss out. The best way to do this is to buy an equity fund – and not just one equity fund. Funds typically invest in one sector, for example UK blue chips, but you need to hold a variety of sectors, styles and geographical areas. I cannot stress how key diversification is for successful, long-term investing.
Thirdly, seek professional advice before making any crucial investment decisions and, if you can, arrange for a professional to manage your portfolio. Many investors assemble their portfolios by buying different funds, run by different management firms, but this is a random approach. Choosing funds to meet long-term investment goals is a complex process with many inter-related pieces. If the pieces do not fit, you may not have the diversification you thought you had and your portfolio may not withstand volatile markets or the test of time.
This goes for your portfolio as a whole, not just the equity component. The amount of various asset classes (shares, bonds, property, cash, and so on) you hold in your portfolio should be chosen strategically according to your goals, circumstances and attitude to risk. You need to discuss all these elements with your financial adviser to ensure he recommends the right mix for you.
In my opinion, equity funds are one of the most promising ways to grow your capital and help ensure it is not eaten away by inflation. With the right approach, advice and management, and the right percentage of your portfolio in the stock markets, equity investment can prove to be very rewarding over the longer term.
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