The Basics of Stock Investing

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Investing in the stock market is one of the greatest ways you can build wealth. One of the world’s wealthiest men, Warren Buffett  became wealthy majorly through stock market investment. Investing in the stock market is more effective if you are still young. In fact, it is recommended that if you are young, most of your investments should be in the stock market because, time is still on your side.

Some experts recommend that to know the percentage of your investment that should be in the stock market, you should subtract your current age from hundred. For example, if you are 38 years old, about 62% of your investment should be in the stock market, while 38% can be in mutual funds and treasury bills and other less volatile paper investments.

However, before jumping into the gold mine of stock market investment, I wish to explain the fundamentals of stock market investment to you.

Basics of stock market investment

A share or stock is a document issued by a company, which entitles its holder to be one of the owners of the company or one of its shareholders. A share is issued by a company or can be purchased from the stock market. By owning a share, you can earn a portion and selling shares you get capital gain. So, your return is the dividend plus the capital gain. A company is generally entitled to create as many shares as it pleases.

Each share is a small piece of ownership. The more shares you own, the more of the company you own, and the more control you have over the company’s operations. Companies sometimes issue different classes of shares, which have different privileges associated with them. So, a corporation creates some shares, and sells them to an investor for an agreed upon price, the corporation now has money. In return, the investor has a degree of ownership in the corporation, and can exercise some control over it. The corporation can continue to issue new shares, as long as it can persuade people to buy them. If the company makes a profit, it may decide to plough the money back into the business or use some of it to pay dividends on the shares to its shareholders.

However, you also run a risk of making a capital loss if you have sold the share at a price below your buying price. A company’s stock price reflects what investors think about the stock, not necessarily what the company is “worth.” For example, companies that are growing quickly often trade at a higher price than the company might currently be “worth.” Stock prices are also affected by all forms of company and market news. Market forces and general investor opinions can also affect share price.

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Owning a stock or a share means you are a partial owner of the company, and you get voting rights in certain company issues. Over the long run, stocks have historically averaged about 10% annual returns. However, stocks offer no guarantee of any returns and can lose value, even in the long run. Investments in stocks can generate returns through dividends, even if the price doesn’t appreciate.

The Stock Market

The stock exchange market is a place where stocks are sold and bought. Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You’ve probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically.

The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighbourhood trying to find a buyer. Really, a stock market is nothing more than a super-sophisticated farmers’ market linking buyers and sellers.

Before we go on, we should distinguish between the two types of markets where stock transactions occur. They are:

  • The primary market and
  • The secondary market

The primary market is where securities are created (by means of an Initial Public Offering, IPO) while, in the secondary market, investors trade previously issued securities without the involvement of the issuing companies. The secondary market is what people are referring to when they talk about the stock market. It is important to understand that the trading of a company’s stock does not directly involve that company.

You will need a stock broker

Every transaction in the stock exchange market is carried out through licensed members called brokers. To trade in shares, you have to approach a broker. A stock broker is a person or a firm that trades on its client’s behalf. You tell them what you want to invest in and they will issue the buy or sell order. Some stock brokers also give out financial advice that you are charged for.

Stock brokers bring people who want to sell their stocks and people who want to buy those stocks together for a fee usually called a commission. In exchange for their advice and the services of buying and selling stocks, the brokerage company deducts their commission from every order you make through them. Commissions are not usually very high. Let’s assume you were to buy N10,000 worth of shares, if your brokerage charges 5% commission (may even be lower than that), that means that the brokerage company will keep back N500 and will buy N9500 worth of stock for you. The same thing applies when you are selling your share. However, it is important to note that the brokerage companies make money from you in form of commission only when you want to sell or buy a share, not when you make profits in the market.

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Types of stock brokers

There are few types of stock brokers and you can choose anyone you want to use depending on your personal need.

1.  Full Service Broker

Here you have an actual living human being advising you on your investments. You can sit with him/her over the table and discuss your investment. He takes a percentage commission on every purchase and sale that you make. A full-service broker can provide a whole lot of services such as investment research advice, tax planning and retirement planning. They can advise you on several aspects of your financial life that you ask them, depending on their competence. These types of brokers are usually common around you.

2. Discount Broker/Online broker

Here you do not have an actual person to help you to select your investments. It’s basically an online affair made possible through the internet. These brokers mail you reports from the stocks you own and can also provide you with research reports on a variety of investments. Discount brokers also charge you when you buy and sell shares, but what is different is that instead of charging you a commission, it’s usually a flat fee.

There are a lot of stock brokers in Nigeria. You can get a list of them when you visit any branch office of the Nigerian Stock office closest to you or by searching them online. I have personally used a number of them over the years until I settled down for one particular one of them due to my satisfaction about the efficiency their services and their integrity. But before you decide on any brokerage firm to use, it may help to research about them and get all information about their terms and conditions so as to make a choice that suits your trading needs.

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How Money is Made in the Stock Market

You can make money in the stock market through three basic ways:

  • Share appreciation: This occurs when the value of a shareholder’s stocks increases as a result of an increase in the share price. You bought at a price and then sell at a higher price. You make capital gain, which is the difference between the amount you bought the stocks and the amount you sold it, assuming you sold at a higher price.
  • Dividends: When a company makes profits, among other things it does with the profit, it also passes some of this profit directly to its shareholders in form of dividends. In most cases, you receive a pay check from the company. Some investors collect their dividends and reinvest it into the company while others may choose to spend it. Reinvesting it may be a better choice.
  • Bonus share issue:  This is the offer of free additional shares to existing shareholders in a company in proportion to the number of shares that the shareholders previously own. Therefore, the value of the total number of shares owned by a shareholder increases through bonus share issue.

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