Stocks as an investment vehicle
Stocks! Shares! The thing that made 1929 an unforgettable year and the thing that makes so many people rich!
When you buy stocks (or shares), you are buying a piece of a company. If all goes well, you will share in their profits (dividends) and the share price will go up. If you would want to sell the shares at a later stage, you might be able to sell it at a profit.
Please look at this article as an introduction to stock investments.
Types of stock investment strategies
Stocks seem to be one of those things that many people see as something the super-rich invest in. Recently, this has become much easier with companies like EasyEquities (in South Africa) and RobinHood in the US.
As with all asset classes, there are many different ways to invest in this asset class. In some way or another, you need an intermediary to buy the shares and stocks. Make sure they’re registered with the Financial Services Board!
It’s important to explain here that you get two approaches: passive and active investing:
- Active investing means you are actively trading shares on a very regular basis
- Passive investing means you’re leaving your shares for the long run – you don’t buy and sell due to something happening in the market
Types of investing
You could invest through an investment broker or invest through a company like EasyEquities that allows you to choose the shares yourself. Concerning strategies, each one has its pros and cons. Here’s an overview of a few strategies:
- Value investing: With this strategy, you buy stocks that are undervalued. One can discover this by analysis of their financial statements – a price-to-book value. A high-income dividend is also a way to identify this type of stock. This is often paired with a long term strategy.
- Penny stock investing: Many stocks are worthless – until it becomes mainstream and booms. Some people invest in these type of companies with the hope (and strategic insight) that they will take off. An example is where Naspers invested in Tencent – and made so much money that it eclipsed their other investments.
- Growth stock investing: This is often seen as the opposite of value investing. Here you will invest in a company due to its intrinsic value that you believe they have, as well as the potential future investments that could come to fruition. Often, the company’s share price will be overvalued.
- Passive index investing (ETFs): Imagine having a computerized set of rules that defines when to buy and sell – and do so only when you essentially have to. Well, ETFs have exactly that. They track certain indicators e.g. the top 40 of a stock exchange and if this changes, they ETF will sell one share and buy another. This makes it less investor intensive and often more diversified than normal share picking investments. Note that I am doing a special mention here – a separate article will follow about ETFs!
The pros and cons
As with all asset classes, shares have some interesting pros and cons.
- Liquidity! If you’ve ever wanted to get rid of your asset to get money, this is the thing!
- The highest returns in the stock market: Consistently stocks have outperformed bonds in the long run.
- Dividends: Many shares will pay you dividends. For passive income, this is probably one of the best ways to get started.
- Diversification: Stocks can easily be diversified. One can invest in stocks in different countries, different sectors and different categories.
- Short term volatility: Stocks can go up and down depending on economic, weather and political factors – just to name a few
- Picking the wrong stock: If you pick the wrong stock, you could end up losing your whole investment. An example is what happened with Steinhoff or Tongaat Hulett with their financial irregularities.
- It takes knowledge and time to analyse a company, their financial statements and the market to make a well-informed decision on what to invest in.
- Some stock brokers will charge a large fee for investing in shares/stocks. Make sure you are aware of all the fees involved.
Quick tax overview
I would like to add a special mention for REITs and unit trusts – I will add a special article on this, but feel this is so close to stocks, they deserve mention in this article.
If you invest in local shares – shares that are on the JSE or ALTX – you will be taxed a flat rate of 20% for the dividend payout. This means no other income tax will be payable on it
If you invest in foreign shares, you will be taxed a bit more advanced:
18-45% tax, with a 25/45 exemption.
What this means is as follows: If you earned R 100 in foreign dividends, the calculation will look like this:
100 x 25/45
= R 55,55 (is exempt from tax)
100 – R 55.55
= R 45.45 (is taxable at your standard tax bracket of your income (18-45 %))
REITs and Unit trusts
There are no exeptions for REITs and unit trusts – you would need to pay the full amount of your income tax on these (18-45 %).
This means if you get a REIT dividend of R 100:
If you are in the 45% tax bracket:
((income tax bracket 45%) / R 100 ) x 100
= R 45 payable in tax
Buying and selling your shares
This might seem more complicated, but I will try and break it down as much as I can
Making a profit on my shares
Work out how much money you’ve made, i.e. the buying price – selling price = profit
When you make a profit – the first R 40 000 is tax-free… Whoohoo!
This means if you had a gain of R 100 000, and you are in a tax bracket of R 45 %:
R 100 000 – R 40 000 (Gain minus the exclusion)
= R 60 000 (Taxable gain)
R 60 000 x (45 / 100)
= R 27 000 payable in tax
Making a loss on my shares
If you’ve made a loss, it will reduce the taxable gains for that year. If you have any capital loss, you can carry it over to the next year.
Ways to invest
As mentioned before, it’s become really convenient over the last few years to invest in stocks.
Brokers and financial advisors
I want to make it clear that with stocks, you need to know what you are doing, or you will lose a lot of money. This is where stock brokers come in. There’s loads of brokers that would be more than willing to take your money and take a profit from your full investment capital. Note that I am all for brokers – as long as they give you a much better return on your investment than you could do yourself.
In my opinion, I advise people to make sure they get the full value from their investment broker – make sure you get the advice, convenience and returns to justify the fees.
Invest directly through online brokers
Though you would like to get away from fees, this is likely not to happen. Certain companies allow you to invest online and don’t take the huge chunk of an ‘advisory’ fee.
One that I have mentioned is EasyEquities – they really do a great job in setting out the fees so that you know exactly what you will be paying. Clarity is one of the most important things when it comes to fees.
Remember that not all shares are equal.
Yet, there is no such thing as a free lunch – diversification is the closest thing you will get to that. Make sure you upskill yourself.
Make sure you know what fees you will be paying.
Invest for the future – don’t think of this as a get rich quick scheme.
Frugal Local runs his own company (Effectify). He does software development and helps small businesses and startups with digital solutions. He enjoys writing articles and simplifying complex things – such as the article you’re reading!