Chapter 5 - HOW TO INVEST DIRECTLY IN THE STOCKMARKET

There are two main ways to invest in the stockmarket. You can invest in a unit linked fund or you can buy shares directly. We recommend that you buy shares directly as the charges involved in unit linked funds eat into your profits for no real benefit. We will deal with unit linked funds in Chapter 6.

Just to revisit our strategy. We recommend that you buy a portfolio of the top 10 Irish shares and hold them for the long term. We recommend that the novice investor should buy Irish shares as they are easy to deal in and you will feel more comfortable with them. When you have a bit of experience you might like to buy shares in companies outside Ireland and this is dealt with at the end of this chapter.

HOW MUCH DO YOU NEED TO INVEST DIRECTLY IN SHARES?

Stockbrokers charge a 1.5% commission on buying shares, but the lowest minimum commission is €25 per deal. (See Which Stockbroker?) So, if you buy €1,000 worth of shares, you will be paying 2.5% commission. On top of that you will have 1% stamp duty, which gives a total initial charge of 3%. This is an acceptable initial cost for a long term investor.

For a well diversified portfolio, you need about 10 shares, so you would need €10,000 to start.

However, if you have only €1,000 there is nothing to stop you buying shares in just one company as long as you appreciate the risk involved.

TABLE 5: INVESTING IN IRISH SHARES

The top Irish companies in Table 5 are well diversified in terms of industry sectors and overseas earnings. Pick any ten of these shares which take your fancy. It's impossible to tell which will be the best performers over the coming years.

Three of the stocks are financials and three of the stocks are in the food industry. Don't select more than two from any sector or you could by overexposed to that sector.

THE MECHANICS OF BUYING SHARES

Some people are intimidated by approaching a stockbroker to buy shares. They believe that there is a mystique attached to it. But it's just like buying or selling anything else. Find which stockbroker gives you the lowest charges for the amounts you want to invest. Check out Askaboutmoney for the lowest charges. Send the broker the money together with identification. Phone them with the order and they will do the rest.

You have a choice whether to hold your shares in certificates or in a stockbroker's nominee account. As a long term investor you are better off getting the share certificates. The dividends will be paid to you directly and won't get lost in the stockbroker's accounts. You will not have to worry about the stockbroker going broke.

WHICH STOCKBROKER

Here are the charges from Irish stockbrokers for small deals in Irish and UK shares .
Campbell O'Connor camocon.ie
1.5% on first IR£7,000. Minimum charge IR£20.
Cost of €2000 deal: €30

Goodbodyonline goodbody.ie
1.25% up to €25,000.Minimum €32.
Cost of €2,000 deal: €32
Shares must be held in a Goodbody nominee account - you can't have share certificates.
There is an annual maintenance charge of IR€20.

BUYING ONLINE

Buying shares online

If you are a frequent buyer and seller of shares, trading online has many advantages. It is much cheaper to buy and sell. It is much quicker - you can watch the prices change and respond immediately. Your shares will be kept in a nominee account and so the administration is a lot easier.

Of course, we don't believe that you should trade frequently. You should buy a selection of shares and hold them for the long term. So, is there any advantage in buying shares online for the long term investor. The situation keeps changing so stay in touch with Askaboutmoney to see what the latest recommendations are.

As of February 2002, there doesn't seem to be any advantage in buying Irish shares online. In most cases, it is cheaper to buy in the normal way through Campbell O'Connor than to buy online. The other advantage of buying in the normal way is that you can get share certificates.

Buying American shares is different. It is expensive to buy American shares offline and it is particularly expensive to get American share certificates. So it seems to be worthwhile to buy online. Check out the full charges situation. There are transaction charges and account maintenance charges. Some contributors to Askaboutmoney have recommended www.etrade.com .

Buying UK shares is cheaper online, but again you have to pay extra to get the share certificates. If there are account maintenance charges for holding shares in a nominee account, then you are better off paying the extra for the share certificates and avoiding the account maintenance fees.

Buying Euroland shares should be straightforward enough as we have the same currency and there should be very low currency transmission costs. It doesn't seem to be possible to hold European shares certificates, so that disadvantage of online trading no longer counts. My own experience of buying shares in a German company through an Irish broker was a disaster and I have avoided European shares since then. However, that was before the introduction of the euro, and systems might be a lot better now. A company which was recommended was www.keytrade.be .

If a broker is going to hold your shares in a nominee account, make sure that the broker is secure. If you buy shares through an Irish broker, you get some protection from the Investors' Compensation Fund. If an American or British broker collapses while holding your portfolio, it might be more difficult to get your money or shares back.

AFTER YOU HAVE BOUGHT SHARES

We strongly recommend that you buy and hold your shares for the long term. It is only natural to follow how your shares are doing. The business pages will have articles about the companies. The internet and the newspapers will report on the share price. But it is very important that you don't do anything based on this information. You will read a newspaper article which refers to a bad outlook for AIB. These articles have just no predictive validity whatsoever. Lots of nervous investors panic when they read this stuff and sell off their shares. Our advice is just to let the overall growth in the market look after your investments. You will have some losers, but in time most should be winners.

DON'T CUT YOUR LOSSES

It is amazing how emotional people become about their shares. You invest in 10 shares. 9 do well but one declines by 50%. It's very tempting to cut your losses and you will read all sorts of pithy statements such as "No one ever went bust cutting their losses". Occasionally these are dressed up in more scientific sounding language such as a "stop-loss system". Again, we say that you are better off doing nothing. You will be tempted to sell off your losers and a year later they might have declined even further. But by the same token, a lot of losers turn around and become star performers.

DON'T TAKE PROFITS

The same people who tell you to cut your losses, may equally argue that no one went bust taking a profit. We argue that you should just let your profits ride.

There are only two situations in which you might want to take profits for strategic reasons. The first £1000 per year of capital gains is exempt from Capital Gains Tax. You might want to sell enough shares each year to take advantage of this. However, while you save £200 tax, you will incur dealing costs and stamp duty, so it might not be worthwhile.

Let's say you buy 5 shares and invest 20% of your money in each. Let's say that company A's share price rises by 300% and the others stay roughly the same. Company A will now represent 50% of your portfolio. This is too high a proportion for any one share, so you should probably sell some of the shares to diversify your portfolio a bit further.

DIVIDENDS

Twice a year (usually), the board of the company will pay a part of the profits to the shareholders as a dividend. The rest will be kept in the company to fund the growth of the business. The dividend will be expressed in pence per share. So if the dividend is 10 pence per share and you have 1000 shares, the company will pay you a dividend of £100.

The company is obliged to deduct 20% Dividend Withholding Tax (DWD), so you will receive only £80.

You will get a cheque together with a Dividend Certificate. Keep the certificate, you will need it for your tax returns.

On your tax returns, you will declare your gross dividend of £100. If you are on the top rate, you will pay £42 tax on this, but you will get a credit for £20. So the additional tax you will have to pay will be £22.

Some companies offer dividend reinvestment schemes. You can use the net dividend to buy shares at the market price. This is particularly attractive for overseas shares where the transaction costs of converting dividends to € can be expensive.

RIGHTS ISSUES

From time to time a company will issue new shares at a discount to existing shareholders. You will have a choice of buying these new shares or else selling your rights to the new shares. It really doesn't make too much of a difference what you do. Some people get the impression that a rights issue makes them a big profit as they are buying shares below the market price. This is not so as their existing shares will decline in price towards the new price.

SCRIP ISSUES/SHARE SPLITS

People seem to like buying shares at around the £10 level. If a company's share rises to £100, people might be less inclined to buy it. So the company issues one free share for every share held. No new capital is raised, so the share should theoretically halve in value exactly from £100 to £50. Bizarrely, during the height of the dot.com fever, such share splits often boosted the price of the share. Of course, it should have no effect whatsoever.

AGMs

As a shareholder, you are entitled to attend and vote at AGMs. They are usually quite formal and dull affairs followed by refreshments. There is no need to attend, but occasionally they can be entertaining when they are controversial.

SHAREHOLDER PERKS

Some companies give special deals to their shareholders. This is big business in British companies but not very popular in Ireland. The Jurys Doyle group give discounts to shareholders who stay in their hotels. Smurfits give holders of 2000 (?) shares discounted trips to the Kclub and free entry into a lottery for a shareholders day out at the K Club.

MONITORING YOUR SHARES

Once you own shares you will be constantly checking how your shares are doing. This is just a natural human response although it can be costly if it causes you to panic. If you had the discipline to check your share prices once a year, you would be better off. You can check your share prices in the daily newspapers, on teletext or on the internet. They are also reported on the Business news on radio and television.

The best site is the Campbell O' Connor site, where you can construct a portfolio of your shares. http://www.camocon.ie

INVESTING IN COMPANIES OUTSIDE IRELAND

ADVANTAGES OF BUYING SHARES IN COMPANIES OUTSIDE IRELAND

While Irish companies are well diversified geographically and sectorally, 50% of the profits come from the Irish economy. If all your shares are in Irish companies this leaves you exposed to factors which might negatively affect the value of Irish shares only: an Irish economic slump, a change in the Irish government's policy towards taxation, a decline in the Irish political situation. By buying shares in companies outside Ireland, you protect against that risk to some extent. You can also buy shares in industries which are not available in Ireland e.g. oil companies or retailers.

DISADVANTAGES OF BUYING SHARES IN COMPANIES OUTSIDE IRELAND

EXCHANGE RISK
If you buy shares in a British company and the share price drops and there is a drop in the value of sterling, you could get hit very badly. Of course this risk has a compensatory benefit in that sterling is as likely to rise in value as it is to fall in value.

NOMINEE SHARES
Apart from British companies it is impossible to hold shares in other companies except through nominees. As a long term buyer and holder of shares, I like to own share certificates directly myself.

INVESTING IN SHARES IN OTHER EURO COUNTRIES

Irish people buy shares quite easily in British and American companies, but have been slow to buy shares in continental European countries. There are a few factors to explain this
- We are more comfortable dealing in companies where the main language is English
- We are much more likely to have heard of the British companies and they are covered in the newspapers much more than European companies
- We feel closer to the British than the Europeans
- Their share dealing systems are much closer to the Irish system
- A lot of Irish people work for American companies and have become shareholders through share option schemes in companies such as Microsoft, Intel, Gateway, Dell and other hi tech companies.

But, in fact, we may be better off investing in shares in companies where the euro is the currency as this removes the currency risk. If you buy shares in Marks and Spencers any gains in the price of the share might be cancelled out by a decline in the value of sterling. If you own shares in a European company, this won't be a factor.

Against that, European shares are very difficult to deal in directly. The various European exchanges all have different systems for buying and selling shares. Shares must be held in nominee accounts - you can't get share certificates. It is very difficult to get information on these companies. It is difficult to get information on the tax treatment of dividend income. And it can be difficult to actually get your hands on the dividends when they are paid into a nominee account.

The top Irish companies earn more than half of their profits outside Ireland, so they are already quite diversified geographically. You have good enough exposure to Ireland, Europe and America.

Some would argue that even still, your portfolio should have much more exposure to the big European companies. While this is advantageous in reducing risk, there is a lot of hassle and expense in buying German or French shares directly. If you want exposure to these markets, you would have to get it through a unit linked fund and the extra charges of unit linked funds are probably not compensated for by the advantage in diversification.

BORROWING TO INVEST IN SHARES

If you had borrowed £1 in 1966 and rolled up the interest each year, you would now owe the bank about £30. If you had invested that £1 in the stockmarket and reinvested the dividends, that investment would be worth £184. So it makes great sense on a simple mathematical basis to borrow to invest in the stockmarket.

SO WHAT IS THE RISK IN BORROWING?

The main risk is a personal risk - that you will panic when the stockmarket goes into a slump.

The next risk is that a sudden crash or long slump might reduce the value of your investments to less than the loan outstanding.

And there is a small risk that history might not repeat itself and that the next slump in the Irish stockmarket might take 30 years to recover from.

YOU SHOULD ONLY BORROW TO INVEST IF YOU WILL BE ABLE TO MAKE THE REPAYMENTS ON THE BORROWINGS FROM OTHER INCOME.

Let's say that Marion Teacher has an income of £30,000 and owns her own house with £20,000 left on her mortgage. She has had a small portfolio of shares for the past 10 years. Despite the downs of the stockmarket, her portfolio is well up and she is thinking of borrowing to invest.

The conventional wisdom is that you can comfortably service borrowings up to about twice your income. So let's say she tops up her mortgage by €40,000 to invest in the stockmarket. This is a perfectly reasonable strategy. Even if the stockmarket goes into a long term slump, she will be able to continue her mortgage repayments. She won't be forced to sell off your shares at a loss. Eventually the stockmarket will recover and she will be in profit. It might take the stockmarket 16 years to recover, but as a long term strategy, she can wait. She is a teacher, so her job and her salary are fairly reliable. She has invested in the stockmarket before so she knows that she can handle the crashes.

Now consider Joe Com. He is 25 years old and has just bought a house for £150k on a salary of £30k. He has a mortgage of £100k. He has never bought shares before but thinks it's a great time to buy into the high tech sector as it has bombed out recently and he "knows the business". He wants to borrow £20k from his bank. He tells them it is for a car loan as they wouldn't give it to him to invest in shares.

Joe should not borrow to invest in shares for many reasons. He is already overborrowed with a loan in excess of three times his annual income. He is employed in the IT sector, so his job is not as secure as Marion. He hasn't experienced the downs of the stockmarket, so he doesn't know if he will panic at the next crash. And he is borrowing at the term loan rate instead of the much cheaper mortgage rate. His main financial objective should be to get his mortgage under control. When his salary increases to about £60k, he can look again at the issue.

The best return comes from a passively managed portfolio of direct investment in shares. If you try to beat the market by buying and selling shares, you will reduce your returns by the charges and stamp duty.
Whereas, if you buy through a unit linked fund, the return will be reduced by at least 1% a year and more typically, 2% a year. This makes it not worth doing

I have received a lump-sum. Should I invest it in the stockmarket or pay off my mortgage.

Forget the lump-sum for the moment. Let's say you have a mortgage of £60,000 and a salary of £50,000 a year. Would you be comfortable extending your mortgage to £100,000 to invest in the stockmarket? This is the exact same question as you pose. If you have a mortgage of £100,000 and you get a lump-sum of £40,000 investing it in the stockmarket is the same as extending a £60,000 mortgage to £100,000.

If you meet the criteria in the box above, then it is ok to invest in the stockmarket.

If you don't have experience of the lows of the stockmarket, then you should use most of the money to pay off your mortgage and get experience with a small part of the balance. If you invest only £10,000, you won't be able to buy 10 different shares. But buy 5 different shares and just live with the extra bit of risk. Check out if this is £10k or £20k

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