The share market explained ... simply

There are endless ways to introduce you to the share market. To be honest, when I began writing this I couldn't figure out the best approach. It's such a huge topic.

Then it hit me, why not just explain the process right from the beginning. Sound ok? Here goes.

New Year's resolution

As we approach the new year, have you thought about becoming a share market investor? Given how much air time the share market receives, and the attention that's paid to the ups and downs of various stocks, you might be surprised to learn that many Australians haven't in fact thought about becoming an investor.

The latest figures from the Australian Tax Office show over a quarter of all private investors are sitting on cash and term deposits earning 'safe' returns (between 1 and 2.5 per cent).

The National President of the Australian Investors Association, Graeme Bottrill, told me that's because there's a lack of financial literacy in the country. In other words, many Australians put share investing in the too hard basket.

That's unfortunate because, although buying shares involves taking on more risk, it does offer returns, on average, much higher than you would receive through a term deposit, for example.

So how do you invest in the share market?

Step 1: You need to decide if you're ok with "risk". If you are "risk loving", you're the type of person that throws caution to the wind. If you're "risk averse", you'll probably be someone who'll take an umbrella to work even if it's just overcast. They're silly examples but hopefully you get my point.

Share market investing is most suited to investors that are comfortable with a degree of risk.

Step 2: Decide whether you would like to trade online DIY-style (discount stockbroking), or if you would like to hire an advisor. This is by no means a rule, but investors with small amounts of money tend to trade online, while investors with big sums of money usually trade through private client advisors or fund managers.

Step 3: Assuming you've decided to go with an online broker, you'll then need to set up an account. With that comes all the nitty gritty paperwork, including providing identification and linking your bank account to your share trading account.

Once you have an account set up, and money in your linked bank account, you're ready to go.

How does the market work?

I'm now going to explain some of the basic aspects of the market. You really should know some of these concepts before you consider share trading.

Share market: The share market is a market where participants buy and sell shares. Prices in the market are governed by the laws of supply and demand. That is, if a particular stock is heavily bid, the price of the stock, all things being equal, will rise.

Stocks and shares: While there's no blanket rule, a "stock" is generally used to describe a company trading on the exchange. A share, on the other hand, is a unit of that stock. I might, for instance, buy 5,000 shares of the stock, BHP.

Indices: These are the figures you see quoted endlessly on the news. The official benchmark index for the Australian stock exchange in the S&P/ASX 200. Another widely used index is the All Ordinaries.

They're both used to give a sense of whether the market, as a whole, closes higher or lower at the end of the day. If you own several different types of stocks, or have a "well-diversified portfolio", the All Ords (as it's called) can give you a good sense of whether you're ahead or behind at the end of the trading day.

Sectors: I mentioned above having a "well-diversified portfolio". That often involves owning stocks from different sectors. The Australian stock market is made of numerous sectors but the most often quoted are the banks, miners, energy stocks, consumer staples (e.g. Woolworths), consumer discretionary (e.g. Myer) and telecommunications (e.g. Telstra).

Stock broker: A stock broker can be an individual, someone who trades shares on your behalf, or a company.

Issuer sponsored versus broker or CHESS sponsored: Once you legally own shares, they need to be 'held' somewhere. That can be through broker sponsorship (CHESS sponsorship), where you receive a Holder Identification Number or HIN number, or it can be through the issuing company's share registry, where you receive a Security Holder Reference Number or SRN.

One benefit to being "broker sponsored" is that you only have one HIN and all paperwork is done through that broker. Silly things like changing your address can also be easier.

Contract notes: When you buy and sell shares the transaction is recorded by way of a contract note. It notes the day of purchase, and the price at which you bought or sold the shares. You should keep contract notes for tax purposes.

Capital gains and dividends: Most people own shares to build wealth. That can come in one of two ways - either the stocks rise in value and you sell them for a higher price than what you bought them for (capital gain), or you benefit from the company's profits as they're made (dividends). Dividends can be used as an alternative income stream if you own large amounts of shares.

Tax: You will need to pay tax on any gains you make in the stock market. You can also make deductions if you incur losses.

Reinvesting (dividend reinvestment plans and share offers): Companies can suggest you reinvest the dividends they pay you in the form of buying more shares. Companies may also decide to raise money exclusively through existing shareholders.

Do I need to watch my shares every hour?

Stock market investing can be exciting. You may find your money grows by the day. Alternatively, you may also watch your wealth disappear.

The bottom line is that you need a plan and an investment horizon. If you've decided to hold your shares for many years, for example, day-to-day stock market movements are largely irrelevant.

On the other hand, if you're in the market to make a 'quick buck', well then, yes, day-to-day movements matter.

Where do I go for information?

Information sources likely to assist you as an investor include company annual reports, market-sensitive announcements (posted to the ASX website), annual general meetings, stock broker research notes and the media.

Volatility and algorithmic trading

Once upon a time, buying and selling shares was a clunky business. Broker assistants would literally have to walk across the road to deliver contract notes to other market participants. These days transactions happen in an instant, and the associated paper work can be stored on your computer.

With this convenience comes volatility.

Traders have developed computer programs that automatically buy and sell shares if certain conditions are met. This means that any major movement in a stock price can be exacerbated by computers triggering large orders all at the one time.

New investors need to be aware that these large price swings can and do occur.

It's up to you

As an investor, you should work out how much risk you're willing to live with.

You should also figure out your investment horizon, and whether you want to make money from buying and selling shares, or if you want to work on building a "passive" income stream through dividends.

The stock market provides an opportunity for Australians to contribute to the growth of some of the nation's most creative companies. Hopefully, folks are also rewarded financially along the way.

Like most things in life though, there are no guarantees.

Note: This is not financial advice. You should consider your individual financial circumstances, or engage a qualified expert to help you do so, before making investment decisions.