My sister asked me a good question the other day. She asked "How do I buy shares?"
Of course I launched into a long and detailed explanation involving dividend yields, return on equity and interest coverage ratios, at which point she interrupted and told me she just wanted to know how buying shares works - how you physically purchase them.
Buying stocks for the first time can be a daunting experience. There is a lot of new terminology which seems especially designed to confuse new investors. So this article is aimed and beginners who what to learn how to buy shares.
Why Do You Want To Buy Shares?
First a quick recap. Before taking the plunge it's worth thinking a little about your reasons for investing. While stock market investments have performed well over the longer term they can be a little volatile over the short term. You only need to look back at the behaviour of world equity markets in late 2008 and early 2009 to see evidence of this.
For this reason, most people consider shares to be a medium to long term investment (sure, there are stock traders who only hold positions for days or even hours before selling but that's another story). Three to five years or longer is typically quoted as a reasonable holding period. So if you're looking for somewhere to stash the money you're saving toward that holiday, the stock market is probably not the place.
What Do You Get When You Buy Shares?
It's important to understand that when you invest in equities, it's more than just a ticker symbol you see quoted in the financial newspapers or on the news at night. You're buying a part ownership in a company - a real business. I think that's a critical point to remember. It's not like money in the bank or a term deposit - you own a small part of a business.
As such you're hoping that the business will grow and that your stake in the business will grow along with it so that you will one day sell your stake for more than you paid for it. You would probably also expect some income in the form of dividends along the way.
So, How Do You Buy Shares?
In practical terms, there are really two ways to invest in shares. You can buy them when a company floats on the Australian Stock Exchange or you can purchase stock in a publicly listed company 'on market'. (There are actually special circumstances where you can purchase shares off-market but these scenarios are beyond the scope of this article.)
Buying Shares In A Float.
When a company lists on the Australian Stock exchange it's called a float. What typically happens is that shares in the company are offered to the public in what's called an Initial Public Offering or IPO.
The company must produce a document called a prospectus which contains information about the history and nature of the business, financial results, any risks inherent in the business and what the future plans for the company are (including what they plan to do with the money raised by the offer). It's a very important document and should be read very carefully by any prospective investor.
It's worth noting that Telstra and Commonwealth Bank shares are the exception when it comes to stock market floats. Typically new companies listing on the ASX are much smaller with shorter operating histories than these two blue chip behemoths. And a fair proportion are outright speculative punts - junior oil and minerals explorers looking for a big resource discovery.
However, if you know what you're looking for, you can occasionally find solid businesses with a good record of profitability listing at reasonable valuations. It can be a good opportunity to get in early on a fast growing company. CSL and Cochlear are two companies which come to mind. Investors in the original float of either of these companies would be sitting on very tidy profits right now.
Although it probably shouldn't be a big consideration, you should also know that there is no brokerage payable when you invest through an IPO.
Buying Shares Through A Stockbroker
Types Of Broker
Full service brokers provide advice to their clients. They will provide recommendations on how to invest your money including what specific stocks to buy and sell. You will normally pay more for this level of service.
Discount brokers will allow you to buy and sell stocks but don't provide personal investment advice. They sometimes offer research information which is general in nature. Their brokerage fees are generally lower.
And speaking brokerage, that takes us nicely into the other main way of buying shares - on the sharemarket through a stock broker. When you buy shares in publicly listed companies through the stock exchange you're buying from another party. You're not buying from the stockbroking firm or from the company itself. There needs to be someone selling in order to buy. The seller may be a private investor like you or they may be an institution like a fund manager. The thing to remember is that you're buying a piece of a business from another party.
Shares listed on the Australian Stock Exchange need to be bought through a stockbroking firm. The stockbroker is responsible for executing purchase and sale transactions on you behalf. For this service they charge a fee called brokerage.
In order to operate as a share broker in Australia, you must be licensed by ASIC (the Australian Securities and Investments Commission). To be safe you should check that your broker is licensed by ASIC.
Before a stockbroker will accept your order, you'll normally have to set up a trading account with them. This is usually a fairly straight forward affair and shouldn't take more than a few days to to complete the process.
Most brokers will also need your bank account details. This is so that funds can be transfered to and from your account to pay for any purchases or receive the proceeds from any sales.
Order Types - 'At Market' and 'At Limit'
When it comes time to make your purchase, there are 2 types of order you can place - 'at market' and 'at limit' orders.
At market orders mean that you are seeking to purchase a set number of shares in a company at whatever the prevailing market price is at that time. So in effect, you will be accepting the offer of a seller who is selling at the lowest price.
At limit orders differ in that instead of just buying at the prevailing market price, you set the price at which you're willing to buy (or sell). This may be above or below the current market price. If you place an at limit order below the current market price, you will need to wait until the share price drops to that level before your order is executed. If the price doesn't get that low then your order wont be executed. I think under ordinary circumstances your order will be valid for 30 days before being purged from the Australian Stock Exchange system. There are a number of exceptions to this rule - I think one of them is when a stock goes ex-dividend.
Most brokers allow you to place orders to buy shares online or over the phone (check out the brokerage fees as they sometimes differ depending on the method you use to place your order). Whichever method you choose, make sure you check, then double check the details of your proposed transaction (make sure you don't have too many zeros), as once the trade takes place you are committed.
Once your trade is executed, there is what's called a settlement period of 3 (business) days. After 3 days the broker 'settles' the trade - they will take the funds from your bank account to pay for the transaction and you will then be the legal owner of those shares.
Unlike in the old days, you wont actually receive a paper share certificate. What you will receive is a CHESS Holding Statement. This statement lists your current shareholding along with any recent transactions. The CHESS system is responsible for handling the settlement of stock market transactions and for maintaining who is the registered owner of each parcel of shares.
There are 2 options for managing your shareholdings. You can choose to be Broker Sponsored or Issuer Sponsored. If you're Broker Sponsored it means that your stockbroker is able to manage your holdings on your behalf. With Issuer Sponsored, the company you hold shares in will manage the holding. Visit the ASX website to find out more about the differences.
I find being broker sponsor to be more convenient as all of my holdings are grouped together and if I ever need to change any details (like my address) it all gets done in one go.
You've probably noted a glaring omission from the article - choosing the best shares to buy. Well that topic is a whole series of articles in itself. I have offered some of my thoughts on this topic in the past and I'll share some more in an upcoming post.