If you’ve a KiwiSaver account, chances are you are already invested in stocks and shares. But if you’re interested in investing in stock markets yourself, rather than have your KiwiSaver provider do it on your behalf, how do you go about it and what do you need to know?
Here, the Beginner’s Guide to Share Trading from the experts at Rockfort Markets reveals everything you need to know.
Beginner’s guide to share trading: What is share trading?
When you buy shares in a company listed on a stock exchange, you receive partial ownership in the company you buy into. This gives you the ability to participate in the upside (or downside) of any share price movement, and allows you to receive a dividend (if any). Owning shares also allows you to participate in voting around important decisions for the company, so you can have a small influence on major decisions the company makes.
Shares in listed companies are, for the most part, purchased through a broker, who then places the order on the stock exchange on your behalf. With the advent of electronic trading, this process is fully automated using online trading platforms provided by the broker.
For example, Rockfort Markets offers the Trader Workstation platform, which allows you to buy and sell shares across many markets in the world at discounted brokerage rates.
Beginner’s guide to share trading: What are dividends?
When you own shares in a company, it can give you an entitlement to receive a dividend. A dividend is a distribution made by the company at set intervals, for example quarterly, semi-annually or yearly. Typically, it follows soon after an earnings announcement.
The dividend you receive is typically paid out of the profits of the company. Sometimes you can choose to reinvest the dividend into more shares or receive a cash distribution.
While buying shares that pay the highest dividend may seem like a good idea, it is not always advisable. Often shares paying very high dividends have a high payout ratio. This refers to the portion of net profit the company is paying out as a dividend. Sometimes it is better to buy dividend stocks that have a lower dividend and lower payout ratio, but more capacity to grow their dividend over time.
It depends on what your own investing objectives are.
Beginner’s guide to share trading:
There are two ways to get involved in shares:
- Investing in shares
- Trading in shares
And it’s vital for a trader to understand how each one works before getting started. This is due to the financial implications each approach can have on profits and losses.
Long-term investment in shares involves buying and holding shares for several years or more. This typically involves researching shares and making a judgement call around either potential growth or value.
There are many investment approaches, and each comes with different risk profiles. But possibly the most common approach is to purchase a diversified portfolio of shares based on a combination of growth, value and dividend yield, in order to gradually build up a passive income to live on at some stage in the future.
Compared to using a fund manager, the benefit of investing directly into shares yourself are the fee savings, and the ability to outperform the average return through careful stock selection. Also, you keep control of your own money and the decision-making process.
The downside, obviously, is that it is difficult to outperform an average benchmark for any length of time. Plus it requires a certain amount of time and effort to research the right shares.
Long-term investors tend to ride out short-term fluctuations in the marketplace. But they do face the risk that shares can lose significant value in short periods of time. And even the overall market can go through long periods of major losses.
The upside is that long-term investors get to be involved in the market during periods when it is rising. In some respects, it’s disadvantageous to be out of the market, because annual returns can be quite high, and long-term investors can take full advantage of this, as they are typically fully invested the entire time.
A long-term investment approach lends itself to a portfolio management style where the investor buys a diversified basket of shares, say five to 20. They then, every so often, either:
- Re-balance their portfolio, meaning they switch one share out for another that they think may offer a better return potential
- Or re-weight their portfolio, meaning selling a portion of some shares, perhaps because they show good profits or might be overvalued, and increasing the investment in other stocks in the portfolio that they think might offer better value
2. TRADING SHARES
Share trading is a more active approach to the market than long-term investing. The general goal of most share traders is to generate an income from the market immediately, as opposed to some time in the future. This can be in order to supplement their current income or, if the trader is exceptionally good, as a way to generate a primary income.
Another difference is share traders look to generate income from buying and selling shares for a profit (at least in aggregate), as opposed to counting on dividend distributions as the main source of income. There are many different approaches to trading, some of the mechanics are outlined below:
Go long or short
Share traders may not limit themselves to trading only to the long side, meaning betting on the market going higher. Quite often share traders target the short side of the market and target stocks they expect to fall in value.
Traders targeting the short side of the market simply sell first and buy back the stock at a later date. Rockfort Markets allows share traders to go both long and short on a stock, but there are sometimes restrictions on short selling. Also the stock has to be available for shorting purposes.
Ultimately, if a share trader is bullish on the market they will take a long position, with the expectation the stock will go higher. And if the share trader is bearish on a stock, they will take a short position, with the expectation the share will go lower.
One of the advantages property investors often tout over share investing is that with property you can leverage your investment by borrowing money to buy a house. The return is then magnified as the investor receives the benefit of any capital appreciation not only on their own money, but on the borrowed money as well. And if a tenant pays rent on the property, it might cover the full interest costs of the property, and even produce a small profit for the landlord.
But what most people don’t realise is that you can do the same thing on companies listed on a stock exchange. Instead of buying a property, you buy into a company and, potentially, use dividends paid out by the company to cover the interest on the borrowed part of the investment.
How does margin lending work?
Margin lending works like this: let’s say you have $10,000 to invest into one share, perhaps as part of a wider portfolio or, if not, perhaps you’re buying into an exchange traded fund and the broker allows you to borrow up to 50% of the investment.
This means that for your $10,000 investment you can purchase $20,000 worth of shares. If the shares go up, you receive the gain on the borrowed portion of your investment as well as on your own funds.
There are several advantages to a strategy using margin lending on shares compared with an investor who borrows to buy a rental property:
Margin lending: the advantages
- You’re not reliant on a tenant paying their rent on time, as companies pay dividends automatically. Also, you don’t have to organise and deal with the bother of collecting rent.
- There is no cost to hold a share, whereas with property you have rates, maintenance and perhaps even body corporate levies or ground rent to pay. When you invest in a company, the management is all taken care of for you and is reflected in the share price.
- Dividends can often be greater than rental income on a property. However this comparison largely depends on the stock or the property.
- Over time share markets, on a cash-on-cash basis, have outperformed property markets in most developed countries.
Also, receiving finance to buy a share is much easier than arranging a mortgage for a property. And interest rates are much the same compared with a residential mortgage.
If you have a margin account, you can automatically leverage your investment on approved securities by 50% at the cash rate of the country where the stock is listed plus 1.5%, and you can buy the share on your trading platform immediately. There are no bank fees or loan approval fees.
Margin lending: the risks
So you might be asking yourself: if margin lending is so good, why aren’t more people doing it? The most common answers to that question are:
- Most people are unaware of what margin lending is
- More importantly, the share market is more volatile than property, with prices marked to market on each trading day. This means that if your investment falls below a certain threshold, your broker will immediately liquidate your investment and you will receive the loss not only on your own funds but on the borrowed funds as well. Because of this, margin lending is considered to carry a high level of risk to your capital. This is the main disadvantage to margin lending compared with property, as the bank may only foreclose if you fail to make your mortgage repayments.
Share trading: costs and taxes
Given share traders are actively turning over their portfolio on a regular basis, it’s important to keep transaction costs down. Therefore it’s always important to look at the brokerage fees for each trade when deciding on which broker to invest through.
The tax position from trading shares varies to that of investing. In New Zealand, unlike investors, who are subject to capital gains tax rules, share traders must pay income tax on any gains they make from trading.
The tax rules and amounts vary depending upon the market being traded, where you live, holding periods and the jurisdiction of the market being traded. For New Zealand traders, international stocks may be subject to the Foreign Investment Fund (FIF) regime, which can be tax advantageous on returns higher than 5%.
It is advisable to seek professional help from a tax accountant who can outline the pros and cons of your trading or investment strategy from a tax standpoint.
Offering dedicated account managers and an expert support team, Rockfort Markets is a registered Financial Service Provider and holds a Derivative Issuer Licence issued by the Financial Markets Authority. It is also a member of Financial Services Complaints Limited. For more information on the services offered by Rockfort Markets, click here.