Back to basics - our rules for stock market investing (part 1)

Start here if you are new to the stock market

«Stock market experience level: Beginner»

I’ve had some really supportive comments, emails and feedback and many from people who are new to stock market investing which has been great to see. This post is the first of hopefully a few that will explain things in more detail for those who’ve just begun their investing journey.

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What is the stock market?

The stock market is just a market where people are able to buy and sell stocks, which just represent a % ownership in a company and hence are also referred to as shares. They are listed for sale on a specific exchange e.g. London Stock Exchange, Euronext or Shanghai Stock Exchange. A way to differentiate between different stock markets is to refer to stock market indices. These indices, such as the most popular S&P 500 in America, track the performance of different parts of the stock market.

Historically, indices were created to track a specific geography e.g. the FTSE 100 tracks the largest 100 companies in the UK, or a specific exchange e.g. Nasdaq 100 lists the top 100 companies, mainly technology companies, on the Nasdaq exchange. But nowadays there are loads of indices covering broader geographic regions such as Emerging Markets or even the World, size of companies (small to large cap.) or specific economic sectors such as Technology, Materials or Consumer Discretionary and within that industries like Software & Services, Metals & Mining or Consumer Durables & Apparel.

Contrary to popular belief the first stock exchange was actually formed in Amsterdam in 1602, as opposed to the New York Stock Exchange in 1792, when shares in the Dutch East India Company were traded for the first time. Back then, the Dutch East India Company was the largest company in the world, and it had a monopoly on trade with Asia. If you watched Johnny Depp in the Pirates of the Caribbean movies you would have heard of their future competitor, the British East India Company.

More recently there are indices for different style factors like Value and Growth which choose companies based on financial characteristics. Value stocks are those that are cheaper than the market average while Growth stocks are those that are growing earnings faster than the market average. Monitoring indices is a good way to see how different stock markets have performed as well as how different types of companies (large vs small, value vs growth etc) have performed. That’s why we refer to them in our Monthly Market reviews (Jan-24 here).

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How do you make money?

When you buy stocks, you can earn income in the form of dividends, if the company decides to pay one, usually worth a small % of the value of the shares you have purchased (on average it has been around 2% for all stocks in the S&P 500 and 4% for UK stocks in the FTSE 100). But the majority of your expected return will come from capital gains. That is the rise in the share price or market value of the company (market value = share price * no. of shares it has offered to investors) as the company grows and becomes more profitable and thus more valuable.

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How to start buying stocks?

To buy a stock you need a stockbroker, either a human (not me in the picture below, although my desk probably looks similar!) or more often these days an online platform which gives you access to various stocks to chose from. Ideally you want to pick a broker which is cheap to use, (there are commission free brokers these days) but has access to a wide variety of stocks. Additionally, you want a broker who offers the right type of account such as tax-advantaged accounts such as a stocks & shares ISA or a SIPP (self-invested personal pension) here in the UK. If you would like we can do a review of major investing platforms and their pros and cons, just ask.

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How to be successful in the stock market?

There are many investing philosophies out there which aim to describe beliefs about how stock markets work and sometimes do not, (markets are the product of collective investor behaviour, and investors aren’t always rational!) and thus philosophies provide the basis of how investors should deploy their capital and how they can exploit inefficiencies to achieve greater returns without taking on additional risk (buying smaller companies for example is generally riskier). There are also many different investment strategies which are more detailed and are employed to provide a way to profit off an investment philosophy. Common strategies are Value and Growth investing (hence respective indices were developed), Quality, Income, Active or Passive Investing, Momentum and many more. They can overlap, so are not mutually exclusive.

‘The individual investor should act consistently as an investor and not as a speculator.’ — Ben Graham

The key to success is having the right philosophy and strategy which should be consistent with your objectives, risk tolerance and other personal circumstances. Having a philosophy and strategy prevents you from getting swayed by others who are legitimately or otherwise, temporarily making money from investing. Moreover, sticking to a philosophy/strategy allows you to keep costs low by not having to switch styles and allows you to build your knowledge and skill at employing your strategy over time.

I will go through my philosophy and process in more detail in a later post but I list below my top investing rules which are linked to my philosophy and strategy and are much more practical to help get you started investing in the stock market.

Rule 1 - Have the right goals and expectations.

Rule 2 - Time is your best friend.

Rule 3 - How much and how often?

Rule 4 - Keep an eye on costs.

Rule 5 - Diversify, Monitor and Rebalance.

In part 2 of this post, released tomorrow, I will go into more detail on what these rules mean, so make sure to check that out.