Gukf News August 22 2009
30 August 2009
Gulf News: "Seek Advice from a Professional"
I am in the process of re-orgnising my finances and am thinking of investing some money in the stock market, but I know absolutely nothing about the pros and cons of such a move. What are the key factors I should think about?
When you buy a lottery ticket, you are confident that the maximum amount you can lose is limited to the price of the ticket. The same logic actually applies to buying stocks – the most that can be lost is what you paid for it.
However, while the lottery offers a grand prize, there is no set prize amount when you invest in a stock. So, how high can a stock prize rise? Some stocks have been going up for years and are still rising, Stocks therefore, at least in theory, have unlimited profit potential.
Unfortunately, there’s no magic formula for making money on the stock market, and the best thing you can do if you are considering investing is to seek the advice of an independent financial advisor.
The first factor to think about is whether you want to invest for the long-term or are looking for short-term gains. Investing in the stock market has proven to be quite rewarding over time, with patience proving to be a key ingredient to success.
Although, stocks go up and down, sometimes with great volatility, stocks generally appreciate over a 60 year period, with most market declines lasting no more than five years. Stocks have historically returned more than 10 percent per annum – routinely outpacing inflation.
There have been only six losing five-year periods in the last 60 such time frames. Patient investors who hold a well-diversified portfolio of stocks have, for the most part, been rewarded. If you are an investor who is capable of waiting it out, the stock market is comparatively safe.
However, there is, of course, always the possibility that you could lose everything you have invested in an individual stock. So even if you don’t lose your entire portfolio, substantial losses can, and do, occur.
The market does fluctuate, which can be both a good and a bad thing. Profits can be made from either an upward move, known as selling long, or a downward move, known as selling short. An incorrect guess can cost you greatly either way.
If you are looking to be a long-term investor, who buys and holds securities, then your maximum potential loss is your entire investment, while your maximum potential gain, in theory, is limitless.
Short-sellers on the other hand, have completely different risks and rewards. If you are planning to be a short-seller then you will make your maximum profit from a downward movement in a stock’s price – hoping that the price will drop as far as possible, even to zero. You can then make a profit equal to the proceeds of the original short sale.
Zero is as far as stock’s price can fall, so that is the short-sellers maximum profit potential. As a short-seller you do not want the stock price to go back up again, because you have sold your stocks at what you believe to be too high a price, and hope to buy then back more cheaply when the price falls.
Buying a stock back at a higher price would result in a loss. And since there is no limit to how high a stock could rise, in this situation, there is no limit to the amount the short-seller could lose.
Generally speaking, bonds and money market funds tend to be the safest investment vehicles, since their prices usually do not fluctuate too erratically. Preferred stocks have slightly more risk, and common stocks are the riskiest of all.
The offset in the high-risk situations is that these stocks also usually also offer you the potential for the greater rewards. While stocks are considered somewhat risky, it cannot be ignored that they have outperform all other financial instruments over the long-term.
With the help of an independent financial advisor you can better decide whether the stock market is an option for you. However, the golden rule is: only invest if you are in it for the long-term – that means at least five years or more. If that’s the case then it is definitely a better place for your money than under the mattress.
By William Hewitt, a District Manager at Nexus Insurance Brokers.