There are generally three different ways to invest in a stock market and today you’ll find out about the advantages and disadvantages of each approach.
Firstly you can handpick your own shares, meaning you select one or a few companies you want to invest in, buy their shares and wait for the magic to happen. The key advantages as well as disadvantages are summarised below.
Advantages of handpicking shares
- you are in complete control of what to invest in: more aggressive, more defensive, environmental friendly companies, tech industry etc.;
- there are no costs between the day you buy and the day you sell;
- you can do extremely well and make a lot of money;
- you might also lose a lot of money;
- you need to know a lot about the individual companies on the stock market in order to make informed decisions.
Another route to investing is through mutual funds, in which case the money of small investors in pooled together. A fund manager is then appointed to manage this fund and he or she decides which shares and bonds to add to the portfolio, based on the latest market developments, company profits and expectations.
Advantages of mutual funds
- Over short-term periods ( 1 – 5 years), mutual funds can significantly outperform the market.
- Investors do not have to make (many) investment decisions, the fund manager will determine what to invest in and when to buy or sell.
Disadvantages of mutual funds
- Mutual funds have many costs and fees, some hidden and some not, that can eat away any returns and investors’ money very quickly.
- Over long periods of time, a mutual fund is extremely unlikely to outperform the market: Most will never beat the market and those that do get better returns only manage to do so for short periods of time.
A third way to invest is through index investing, in which you buy shares of every single company in a particular index in the same proportion as their relative size in the market. In this way you basically copy the market and therefore will get almost exactly the same returns as the market average.
Advantages of index investing
- the only decision you need to make is which market(s) to follow and how much of your portfolio you want to put into shares and how much into bonds;
- Costs are very low;
- You will always get more or less the market average return.
- You will never beat the market. Your maximum return will be the market’s average;
- You might end up with shares you do not want;
- Trading often only happens at set moments, so you can not have instant access to your assets or respond quickly if there is a sudden drop or rise in prices.
Today’s challenge is to find out more about investment options available to you and in your country: find brokers, details of the funds they offer, fees as well as minimum contribution and average results / performance. Just gather information at this stage and once you’re done, let us know in the Facebook Group or via any other social medium using #31DayChallengeToFE that you have completed this challenge. If you’d like to read more about the different ways to invest, make sure to check out Step 50: Investing through Handpicking Shares, Step 51: Investing through Mutual Funds and Step 52: Investing through Index Funds.