The stock market is highly affected by the current state of national and international economies, which means investing can be risky. Understanding what you are investing in – before purchasing any shares – will help minimise risks. These 9 things should always be taken into consideration before investing in any type of share.
1. Market Capitalisation on the Stock Market
Market capitalisation refers to the value of all outstanding common shares for a company multiplied by its current share price on the stock market. The market cap also includes certain types of securities that have been approved by the board to increase the size of the company’s equity without having an immediate influence on earnings per share or net tangible assets. Due to this, it is one of the most popular indicators used when assessing a company’s financial size and therefore offers some general advice into investing in that company.
2. The Company’s Financial Position
Insights into the financial position for a publicly-listed company can be obtained by contacting the investor relations office, or online through each company’s financial statements (which can often be found via their website). The statement will list assets and liabilities, as well as provide information on past performance, earnings, revenue, dividends paid out to shareholders, stockholders’ equity (a.k.a book value), capital structure (equity vs. debt), liquidity ratios and stock data including historical prices and volume figures. These are considered the key factors when investing in any type of share because they indicate how strong or weak a company is, financially. The main goal of investing is ultimately making money off these shares after all! However, they don’t necessarily give the full picture – so it becomes your job as an investor to always seek out additional information before you start investing.
3. The Company’s Business Model
The company’s business model is important because it outlines how the company makes money and what products or services they provide to customers. Without investing in companies’ stocks investors would not get access to investing so knowing how companies generate revenue is essential knowledge. While there are many different ways companies generate revenue, some types of businesses tend to be riskier than others. Here’s a quick breakdown of different types of businesses:
- Companies that directly offer goods or services (e.g., restaurants, clothing retailers, supermarkets etc.) usually take on the least amount of risk because the company already has a large base of repeat customers so it is unlikely that these stocks will ever fall below $0.
- Companies that indirectly offer goods or services include most manufacturing operations and mining companies. These types of businesses take on more risk than others because they must initially invest in production facilities and equipment before starting to generate revenue, and they may not necessarily know what the demand for their range of products will be like when they start selling.
- Companies with a Research & Development focus invest in creating new technologies, goods or services that may not even be offered to consumers yet. While investing in these companies can lead to large returns (if their R&D department is successful, that is), you should also consider the high amount of risk involved if their R&D efforts fail.
“Never invest in a business you cannot understand.”Warren Buffett
4. Managed Funds
Managed funds are investment vehicles that pool together the investments of many investors so they can purchase or sell larger amounts of stocks on behalf of their investing clients. Knowing how to invest in managed funds is an important first step for investing beginners because investing in these can be easier than investing directly on the stock market, especially if you have a smaller amount to invest.
Some of the different types of managed funds include unit trusts, bond funds and exchange-traded funds (ETFs). For investing beginners, understanding how this work is a good idea before investing in them because it can be easy for you to lose money if you don’t know what you’re doing.
5. How Long You Plan to Hold Your Investment For
When investing it is important to be aware of how long you plan to hold your investment because this will influence your buying decisions. What is/are your investment goals and objectives? If you are investing with the intention of holding onto your investment for longer, then investing in high risk but high return opportunities can be advantageous because if they do not pan out then there is that much more time left to recover.
On the other hand, investing in low-risk investments such as cash and bonds can be better for those investing with a shorter timeframe because there is less time for the investment to lose all of its value
6. Where You Plan to Purchase the Investment From
When investing it is important to consider where you plan on purchasing your investment from because different investing platforms – such as Robo-advisers, hiring a financial adviser, investing through superannuation, investing through your self-managed super fund (SMSF) or investing via online brokers (e.g., CommSec, SelfWealth etc.) – carry varying levels of risk.
Robo-investing carries lower risks than most trading platforms because there are no humans involved in making decisions so costs associated with human error is removed.
Investing with a financial advisor involves contacting an individual who will then recommend a suitable investment strategy and financial advice for which you must pay a fee. Hiring a financial adviser also comes with the added risk of investing through a biased perspective because the financial advice they give may be influenced by commissions received from brokering investing products on their behalf.
Investing via your SMSF (which is only advisable for those who truly understand investing and its risks) can be advantageous because you will not pay any fees which allow the money that would have been spent over the last few decades to compound – thus increasing returns.
Finally, choosing to trade via online brokers (e.g., CommSec, SelfWealth etc.) carries a higher level of risk because you would have less protection compared to investing with a financial adviser. However, as an independent investor, you would undertake a hands-on approach to investing and have more control over your own portfolio, investment products and investment objectives.
7. The Type of Stock You Are Investing In
When investing it is important to consider what type of stock you are purchasing because there are varying levels of risk associated with each different type. For example, investing in a blue-chip stock refers to investing in a company on the Australian Securities Exchange (ASX) that has been operating for more than 25 years and has managed to sustain consistent financial growth over the last few decades. Investing in shares of this nature is generally less risky than investing in high-growth companies because blue-chip stocks are more established.
Conversely investing in a penny stock refers to investing in an unlisted company on the Australian Securities Exchange (ASX) that either has very little assets or it operates at a loss. These types of companies tend to carry high levels of risk due to their lack of track record, few shareholders (which makes it difficult for them to raise capital), inability to produce consistent financial statements and a lack of liquidity. Investing in penny stocks is best avoided if a person wants a greater return on their investment dollar because investing in these types of companies comes with an increased risk that you will lose all your money.
8. Seek professional advice to better understand investment returns & risks
Investment returns are inherently linked to investing risks. When investing in any kind of security it is important to be aware of both your potential return and potential loss so that you can make informed investment decisions and achieve your financial goals.
To better understand investing returns and risks, it is important to seek professional advice. Professional advice can help an investor determine their risk tolerance and diversify their investments across different asset classes. This will enable the investor to create a strong portfolio with minimal risk of losing money.
9. Consider your risk appetite
It is also important to consider your risk appetite and seek professional advice where needed. Investors with a high-risk tolerance are prepared to lose some or all of their money so they can increase the potential return on their investment; whereas investors with a low-risk appetite may prefer to invest in “safer” alternatives such as superannuation and term deposits so they can minimise their losses and/or maintain the same level of income.
This list is by no means exhaustive or comprehensive – there are many other factors that need to be taken into account when deciding whether a particular investment will suit your investment goals. However, these ten points should help provide a general framework for thinking about what you want to achieve with an investment portfolio and how it might affect your long-term goals. If those considerations still seem too complex to manage on our own, don’t worry! We have created a portfolio management platform that does all the work of managing all of your investments in one place. Sign up today for a 30-day free trial.