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Beginner’s guide to investing in financial markets: South Africa 2021

Posted on Jul 15, 2021 by Staff Writer

Rateweb | South Africa

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Whilst the idea of investing is noble (I mean, it sounds interesting, right – and cool too – who doesn’t want to share screenshots of their gains on their portfolio) – the truth is, it’s not that easy.

If it were easy, wouldn’t everyone be an investor, and the country would not have a reputation of having one of the lowest levels of savings and investments in the world.  

Investing has for a long time been a game reserved for the elite and the wealthy because of the high initial capital required to start. For a long time, the financial barriers to entry have denied the youth and low-income earners the opportunity to participate in the stock market. 

But times have changed, and technology is opening up space for young and low-income earners to invest and save for the future. 

New fintech companies are pioneering innovations that make it easier for more people to invest. These innovations have caused the initial costs and investing fees involved in traditional investing to drop over the years. In addition, some platforms bring fractional share ownership and fractional property rights into mobile-based platforms, making investing more inclusive.

Could you think of a better timing, especially for those who believe in the F.I.R.E movement (Financially Independent, Retire Early). Technology indeed eliminates the initial barrier to investment instruments (institutional barriers and bias). However, most young and new investors still find it difficult to take the first step because of a lack of proper understanding of financial markets. 

Of course, registering your EasyEquities account is easy. Putting aside the first R100 to deposit into your account is also arguably easy. The hard part is committing your money into a market that you do not understand. 

If you do not know what you are doing and how to find good opportunities on the stock market, you may just have to use your money for something else rather than risk losing it all in something you do not understand, right?

It seems like the logical thing to do – but one of the truths about investing is that you need to start early to maximise the benefit from compounding returns. The longer you keep your money in an interest-bearing investment, the more your money grows.

Financial advisors will give the general advice to start early and start educating yourself about investing in financial markets. This is why financial education is important. Unfortunately, most of us were never taught financial education at home or school, and money conversations remain taboo. 

This article is a long read – a deep dive into the basics of investments in a language that is more accessible to new investors. You may want to bookmark this article for later. But first – the fundamentals –

What is the difference between saving and investing?

The two terms “saving” and “investing” are commonly used interchangeably. Mostly because they serve the same purpose – to preserve money or funds for future use. One of the common motivations is to save for retirement or your children’s education. For some people, you may be motivated by short term goals such as saving for the tech upgrade or the holiday you always wanted. 

Both saving and investments are key ingredients to a healthy financial plan, and you should be looking towards using both. When you save money, you are reserving funds for a specific goal, usually in the short term. Your savings are an asset, where an asset is anything that you own that has monetary value. Other examples of assets include property, vehicles, and stocks. 

Depending on many factors, your assets may increase or decrease in value. For example, if you buy a car today, when you sell it in the future, you will typically sell it at a lower price than the price that you initially bought the car for. If you buy a stock in a company, depending on whether the company does well, the value may increase. This will mean that the value of your assets will also increase. 

But how do savings differ from investing?

  1. Length of Time

One of the differences is the length of time to commit your money to a saving or investment account. You will generally build your savings towards short-term goals like your next tech upgrade, holiday, or wardrobe overhaul. You may also put money aside just for you to have some extra money in case of emergencies. 

On the other hand, you can think of investing as managing and growing your existing assets in the longer term. This can include long term goals like setting up a retirement fund. Other investors invest their money intending to secure extra income in the future through capital gains, dividends, and interest payments. Some investment vehicles can bring regular income that you can survive on if you plan your retirement well. 

  1. The ease of accessing your money: saving vs investing

The other difference is how easily you can access your money. You have many choices of how you decide to save your money. You can save through a stokvel/landing club, put aside hard cash or deposit into a savings account. When you save money, you usually want the option that makes it more difficult to spend on the things you did not intend to spend on. It is also important that you make sure you can easily access the funds when you need the money. 

For this reason, withdrawals from bank-held savings accounts are usually quicker. On the other hand, investments are made for a longer period, making it harder to access the money within short periods. Sometimes, there are fees attached to early withdrawals from investment accounts.

  1. Amount of risk and potential for returns

The other major difference between saving and investing is the amount of risk involved. Money that you put away in a savings account is relatively safer because there is very little risk of anything happening to it in a savings account. However, it will not grow significantly because most savings accounts offer low-interest rates on your balance. 

In contrast, if you invest your money, there is a greater chance that you will profit or lose money. The chances of your investments growing or losing value depends on how the market performs. However, the lows and highs of the market should even out if you’re willing to wait out tough market conditions and hold on to your investments for a longer time.

Even though your money in a savings account will earn interest, the amount will generally be lower than the return on a longer-term investment. This is because investments have more growth potential and should grow over time. This means that the total growth could be more valuable than the interest earned in a savings account. But investments also have a higher risk of losing value. 

Saving and investing have different advantages and disadvantages, but both are essential for a healthy financial plan. However, they serve different purposes over different periods, so you should use them wisely to accommodate your financial needs.

What is the difference between trading and investing in financial markets?

Another concept that many may find confusing is the difference between investing and trading. Some use the two terms interchangeably. Because both trading and investing take place in financial markets, it is no surprise why there may be confusion. 

However, trading and investing have different strategies and approaches to financial markets with very different objectives. One of the only things that are similar between investing and trading is trying to achieve a profit for the investor or trader.

Investing typically has a long-term time frame spanning a few years to even a couple of decades. Investors on the stock market primarily look to build wealth by gaining a return on investment. Returns are generally realised through an increase in the share price or dividends received from owning shares. 

As an investor, you would typically look out for stocks or shares that you can buy at a lower price in anticipation that the share would increase in value to sell them at a higher price in the future. Additionally, you can also realise returns or gains on your investments when you invest in companies that pay out dividends. 

Normally investors try to increase their profits by reinvesting any dividends received from their shares. You can do this by reinvesting either in the same share or in other shares. Other investors adopt an investment strategy where they use dividend pay-outs as regular income streams; much the same way property owners earn from rental income. You can decide to use either strategy or even a hybrid strategy and reinvest some of your dividend earnings or treat them as additional income. 

As an investor considering investing in a company, you should be more focused on the company’s fundamentals, taking into account the company’s performance. Some of the factors you can look at are the market conditions in the company’s industry, the company’s leadership, and metrics such as Price/Earnings ratios and the company’s financial results. 

Because an investor has a long-term outlook, investors are normally willing to hold on to their shares even if the share price falls, as long as their analysis still shows a positive outcome for their investment.

On the other hand, trading is normally focused on the share price movements taking place over shorter periods than the long-term periods of an investor. A trader is more concerned with buying a share at a low price in anticipation of selling at the peak of the share price before the price reverses. This is done in order to maximise the profit on the trade. 

Traders also use short selling to profit from a drop in the share price. Short selling is a type of trading in which a trader borrows a share and sells it expecting that the share price will fall. They would buy it back at a lower share price before returning the share to the original owner. 

Traders often profit from short-term effects on a share price or a market using events like interest rate changes and big news. Strategies used by traders vary. Scalp traders typically hold a share for minutes or even seconds. On the other hand, position traders can hold a share for months or even years.

Understanding financial markets. What is the difference between Bull and Bear Markets?

You may have heard and wondered what analysts mean when they say statements such as “This commodity is experiencing a bull run” or something along the lines of “Investors are having a bearish outlook on the industry’s future performance”. Bull and bear markets are terms used in the language of stock trading and investing to describe market conditions. 

These are terms you should know if you are considering participating in the stock market. These terms refer to the movement of a stock’s price or an investor’s sentiments about a stock or market. Prices in a bull market follow an upward trend as the price is increasing in value. On the other hand, prices in a bear market are decreasing in value, or in other words, the price is trending downward.

A bull market is typically associated with a growing economy, in which demand exceeds supply and consumers have more money to spend. A bear market typically characterises a weakening economy. These are economies in which supply exceeds demand, with most companies realising a decrease in profits, reducing investor confidence.

Investors typically choose investments with a bullish outlook because they want to buy a stock when the share price is low and then sell it later when the price increases.

What is The Bid-Ask Spread? And why is it important?

Another concept you should understand before you enter the stock market is the Bid-Ask Spread. The trade of assets and stocks in the markets happens between buyers and sellers. The buyers and sellers are the ones that determine prices in the market for assets. Potential buyers place a bid price in the market for the assets they intend to buy. Sellers who own the assets place an asking price in the market. 

The bid price set by the buyers and the asking price set by the sellers is usually not the same. This difference between the highest bid price and the lowest ask price is referred to as the bid-ask spread. Put simply, the bid-ask spread represents the discrepancy in price between what sellers are willing to accept and what buyers want to pay.

The bid-ask spread can be defined in absolute terms. For instance, if the bid price for an asset is R38 and the asking price is R40, then the bid-ask spread would be R2.

The bid-ask spread can also be represented in relative terms, say as a percentage. This is important if you want to compare different markets or shares that may be trading at different prices. Considering the example above, the bid-ask spread represented as a percentage of the asking price is 4% (R2 / R40 x 100). 

So why should you bother about the bid-ask spread? 

If you consider buying an asset, you may want to know how easy it is to sell that asset, depending on your objectives. Liquidity is the term that is used to describe how easy or how frequently assets can be traded on the market. You would then use the bid-ask spread to measure the liquidity of the asset you intend to buy on the stock market. 

Assets with a low bid-ask spread will have high liquidity, where ones with a high bid-ask spread will be less liquid. Low liquidity may indicate that current holders of an asset are unwilling to let go of their holdings. It may indicate that potential buyers are unwilling to pay more for the asset. This is, however, not indicative of the performance of the asset in the long term. Still, it may imply that holders of those assets may have to take a loss if they fail to sell the asset when they want to. 

Understanding Investing Risks

You may be familiar with the scenario of Ponzi schemes -maybe you gained from that pyramid scheme you joined a few years ago.  But the majority of people who join Ponzi schemes are not so lucky and tend to lose all their money without realising any returns. 

If you joined knowingly aware that it was a pyramid scheme, you knew of the risks involved in “investing” in that scheme and secretly hoped that luck would be on your side and receive your returns before the scheme collapsed. 

However, some victims are not aware of the risks involved before joining. Sometimes people join because someone they trust joined and convinced them that it was a good opportunity to make money. 

However, organisers of the schemes often deceive people. Promises of quick returns with no risks and more returns if you recruit more members and “invest” more to keep the “train” running lure people to put their money and recruit more members. You may have heard the stories of people who lost all their savings or got into debt while gambling on these schemes. But how does this happen, you wonder?

Some Ponzi scheme organisers promise to invest the money in low-risk investments that guarantee high returns. Instead of investing the money, pay-outs will be made to the older recruits. But because there are little or no legitimate earnings, the scheme survives on more new recruits until it becomes hard to recruit more people, suppose large cash-outs by the existing members happen. If that happens, it can also cause the pyramid scheme to collapse if the remaining amount of money flowing in the system is not enough to sustain it. 

But because Ponzi schemes also use the term “investing”, some people may frown upon “investing” in the stock market. You can indeed grow your wealth by trading stocks and investing in the stock market, but there is a downside to it – the potential of blowing your money. 

Investing risk is the amount you stand to lose if your investment fails. This could be either because your investment has decreased below its initial value, or it has not met your expected investment goals.

You need to know the risks involved in the assets and markets you are interested in before putting your money. Knowing the risks before you commit your money will help you manage your risks appropriately, keeping in mind that a greater risk may lead to a greater potential return – or potential loss. 

The general advice is that you should not risk what you cannot afford to lose. This is why most financial advisors generally recommend people to grow their savings account or emergency fund before building an investment portfolio. 

Different asset classes are associated with different levels of risk. Two of the most common low-risk asset classes are cash and government bonds. These will have low investment risks and also lower potential returns than equities and cryptocurrencies that are riskier.

There are more risks associated with investing than just the possibility of the share price depreciating. You need to be aware of other risks such as;

● Business risk – you may want to consider if the company you buy shares from can generate significant revenue in the long term to cover its expenses and operational costs. You will want to consider the nature of the business, how the company runs operations, and the outlook on the industry that the company operates in daily operations.

● Credit risk -what is the risk that the borrower can meet their contractual obligations on the bond? Credit risk is generally associated with bonds. You can invest in either government bonds or corporate bonds. Government bonds typically have a lower credit risk than corporate bonds – but corporate bonds have higher potential for returns. 

● Country risk – is relevant to more than the government bonds issued by a country. Country risk encompasses the relationships the country has with its trading partners and how these affect other financial instruments such as equities. To see the effect of country risk, you may want to look at the Trade War between the US and China and how it affected other countries that primarily trade with these countries.

● Liquidity risk – This is the risk of how easy it is to sell your assets should you wish to. Low liquidity investments may be difficult to sell since there are few or no willing buyers in the market. You may have to take a loss should you fail to sell at the price that you wanted to sell.

● Foreign exchange risk – is the risk involved when you invest in other countries in a different currency. Such investments are referred to as offshore investments. Whilst your offshore investments may perform well, the currency of your investments may lose value against your currency, which may cause your investment to have little or no value if evaluated in your country’s currency. You are also exposed to this risk even if you don’t have offshore investments, but your local investments are exposed to assets in other countries. 

Managing investment risk: Building a portfolio and diversification

Diversification is a strategy for reducing investment risk by incorporating a diverse range of investments into your portfolio. Risk management is important in order to reduce the risk of one of your investments performing poorly and negatively affecting the gains realised in the rest of your portfolio. 

To hedge the risk of any other shares, investors will typically look for shares to add to their portfolio that have little to no correlation to other shares in their portfolio. If you invested in a local mining firm, for example, you could consider adding a property company to your portfolio because you generally don’t expect the property sector to be affected if the mining industry suffers. 

Diversifying a portfolio through different asset classes, such as equities, bonds/fixed income, and cash is another option. For example, if the equity market goes into a bear market, as an investor, you can expect higher interest rates, which means you will get a bigger return from your fixed income and cash than you would gain from the equity portion of your portfolio.

Fractional Share Rights.

To explain how the concept of fractional share rights is ground breaking, consider that with as little as R1, you can own fractional share rights in a JSE listed company or international stocks and assets that you would otherwise not afford for that price. Since shares typically trade in bundles of 100, you would typically need to spend more to have a more diversified portfolio to spread your risk. But with fractional shares, for the price of one high-value share, you can own fractions of different shares and a wide variety of assets such as stocks in different markets, bonds, property and ETFs for a diversified portfolio. 

Understanding asset classes.

An asset class refers to a collection of investments with comparable characteristics and that are subject to the same laws and regulations. Equities (stocks), fixed income (bonds), and cash equivalents or money market instruments have traditionally been the three basic asset classes. Real estate, commodities, cryptocurrencies, futures, and other financial derivatives are now included in the asset class mix. Investment assets can be tangible items such as real estate and cash, or intangible, as is the case of stocks that investors buy and sell in order to generate additional revenue. 

Asset class categories are thought of as investment vehicles that can be used to diversify a portfolio. There is usually relatively little correlation between diverse asset classes, and in some circumstances, a negative correlation. In any given market situation, each asset class is expected to present different risk and return characteristics. When it comes to optimising return, investors frequently reduce portfolio risk by diversifying across different asset classes.

Different asset types have different cash flow streams as well as different risk levels. Investing in a variety of asset types ensures a certain level of investment diversification. Diversification lowers your risk and increases your chances of making a profit.

Understanding the difference between ETFs and Stocks

Stocks, often known as equities, are publicly traded company shares. Owning shares of a stock is the equivalent of owning a little piece of a company. A company may sell stock to raise funds for a variety of reasons. Some stocks allow shareholders to vote at shareholder meetings. Some equities pay dividends, which are a portion of the company’s profits paid to shareholders.

A stock’s value fluctuates depending on the company, the economy, and various other factors. The majority of equities are common shares, which allow shareholders to vote at meetings. Preferred shares, on the other hand, do not provide this option but may provide the holder with higher returns on the company’s earnings. Penny stocks, or shares in small businesses, are also available. Penny stock trading is risky and regarded as speculative.

Exchange-traded funds (ETFs) are a sort of professionally managed, pooled investment. Stocks, commodities, bonds, and other securities will be purchased by the ETF and placed in a basket. The basket of holdings will subsequently be sold to investors in the form of shares. To maintain the fund aligned to any specified investment aim, managers will buy or sell portions of the basket assets. An ETF may, for example, track a specific index or industry sector, purchasing only those assets to include in the basket. ETFs, like stocks, are traded on exchanges.

ETF share prices fluctuate throughout the day depending on the same factors that affect stock prices. After deducting the cost of professional management, ETFs normally pay a share of earnings to investors. Some ETFs focus on a single industry, country, currency, or bond. 

Returns on ETFs tend to be in the average range. But that typically makes them safe – or safer -than many stocks because stocks often exhibit more volatility depending on the economy, global situations, and the underlying company itself.

Your personal risk tolerance might play a large role in determining which option is best for you. Risks include your ability to watch the investment’s value fluctuate dramatically, the amount of time you have before you need to withdraw invested assets, and your earning potential. To obtain a better idea of the direction you wish to follow, compare your choices against these factors.

Investors might choose to take large risks and be aggressive or limit all risk and be conservative.

Individual company risks can be mitigated by investing in ETFs. With a single investment, investors can participate in an entire index or industry.

How to read a stock chart

When you hear the term stock market, there is a good chance that the first thing to come to mind is a big office with many screens showing codes and numbers written in the red and green text – and a whole lot of charts. 

Stock charts are a useful tool for understanding the behaviour of stock markets over a period of time. Although they are useful, reading stock charts can be quite intimidating for beginners. But understanding stock analysis and incorporating it as part of your investing routine will come in handy when looking out for great investment opportunities. Stock chart mastery will help you figure out the right time to buy or sell, giving you a little more confidence about your trades rather than solely relying on opinions and headlines.

It is in the nature of stock markets for share prices to rise and fall on a daily basis. Although the market is not 100 per cent predictable, a good analysis will help you interpret price and volume action so that you can keep the price fluctuations in perspective. This will help you in making a decision to hold or sell your stocks.

What are the elements of a stock chart?

Stock charts show the basic information on a stock – price and volume over a certain period of time. Price movements of the stock are represented as trendlines. The price of the stock is shown on the vertical axis or the side axis. The horizontal or bottom axis shows the time period, which you can customise for the selected chart. This can be anything from a day or many years to see the historic price movements of the stock. 

Trend Line: You can use a line chart to observe the price movements over a period of time. You will be able to track a trendline of that stock for the time period you selected. This will give you information about the general direction of the share price.

The stock chart can also be presented in the form of bar charts. Bar charts will show you the highest and lowest prices as well as the closing price of a stock. The bars will show the stock information for a single time unit across a specific timeframe. For example, you could be looking at a weekly chart, and the bars could show the daily highest and lowest prices and the closing price for each day in that week.

You can also select a candlestick chart view, which looks a little bit more complex. Candlestick charts use the stock’s open, high, low and close prices to show stock trends. You can use the open and close prices to figure out if there was an upward or downward momentum for the stock. Clear or green boxes are usually used to show periods when the closing price was higher than the opening price, and red or pink boxes show when the closing price was lower than the previous day. 

Trading Volume: Aside from the stock’s price movement, another important consideration to make when reading a stock chart is the stock’s trading volume. The volume is usually represented by green and red bars at the bottom of the stock chart (or sometimes blue or purple bars). When looking at trading volume, it is essential to look for spikes in trading volumes, which might signal the strength of a trend. If the share price falls and the trading volume rises, it could indicate a strong downward trend. However, if the volume is significantly lower than typical, it could indicate that the market’s major investors, who largely drive the share price, are not selling aggressively.

Lines of Support and Resistance: These are another key feature to look at on a stock chart. When a stock rises or falls in price, it usually does so within the confines of what is known as support and resistance lines. In simple terms, a support line is a price below which the stock is unlikely to fall -“supporting” the stock to keep it trading above that price. On the other hand, the resistance line is a price above which the stock normally does not trade. It acts as a ceiling and “resists” the stock from trading above that top price.

Stock prices tend to fluctuate between these support and resistance lines. But sometimes, stocks break through these support and resistance lines. If the stock breaks above the resistance line, that resistance line becomes the new support line. If a stock falls below the support line, however, the converse is true. 

Support and resistance lines are useful for forecasting or comprehending a stock’s overall trend and when it might go up or down.

Besides showing a stock’s price movements and trends, stock charts may also include additional information that you may want to consider about the company and the stock’s past performance. Other information that you can learn from a stock chart include earnings per share.

Earnings per Share (EPS): Earnings per share, or EPS, is a strong indicator of how well a firm is performing. And can be found on many stock charts. As an investor, you may want to consider the portion of the company’s profits that your shares will have a stake in, earnings per share (EPS) measures the number of net profits a company has earned per share of its stock. This value is generally updated every quarter following the release of the company’s earnings report.

Conclusion 

The article is for educational purposes only and does not constitute financial advice. It is intended to give you the foundational knowledge you need about the stock market. 

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