Should I borrow money to invest?
Investors often wonder whether they should borrow money to play the market. Since each investor’s situation is unique, advice must be tailored to suit their particular needs.
As a general rule, the stock market is inherently risky and volatile, and you should only risk what you can afford to lose.
There are times when using debt in the market is appropriate, but it is the domain of the experienced investor. If you do not fully understand the high-risk nature of leveraged positions, you should avoid using debt.
The simple answer is just to be careful when it comes to borrowing. As Warren Buffett, arguably the world’s greatest stock market investor, says, ‘debt is a dagger attached to the steering wheel, pointed at the heart of the driver’.
How many shares do I buy?
Beginners to the market want to know how much they should invest in each different share they buy. It is impossible to recommend investing a specific amount in a share. Some investors have $4000 to invest, while some others may have $400,000. Furthermore, different investor profiles require different consideration in terms of capital allocation.
As a general rule, never put much less than $2500 into one investment. If you have $9000 to invest, you might put $3000 in three stocks. Never invest $1000 in nine stocks, as the cost of brokerage will take the lion’s share of any profits.
Paying $40 to buy and $40 to sell (with a non-advisory broker) means that if you buy $1000 worth of shares, the shares will have to go up 8% before you hit the break-even point ($80 brokerage is 8% of your $1000 investment).
Obviously, something to remember when buying is that the cheaper the brokerage, the smaller amount you can get away with investing without brokerage taking too large a share of profits. Therefore, the minimum figure of $2500 can be lowered slightly further if buying online.
The figure of 1% might be an easier guide to follow. Try not to spend more on brokerage than the value of 1% of your investment. Therefore, if you are spending $2500 on a trade, try not to spend more than $25 (1% of $3000) on brokerage.
The $2500 rule does not take into account how much brokerage you are paying, whereas the 1% rule applies across the board.
When starting out, is a $70 share too expensive to buy?
This is one of the biggest misconceptions that investors have when new to the market. It is important to understand that you can buy a $70 share as easily as you can buy a 70c share. This is an important point to consider. People say things like; ‘I can’t buy shares like Rio Tinto and Macquarie Bank because they cost too much. Can’t you recommend some less expensive shares?’ They believe they don’t have enough money for shares above $10, for example.
This is wrong! Whether you spend $5000 by buying 64 Macquarie Bank shares at $78, or 7500 Kimberley Diamond shares at 67c a share, it doesn’t matter. It’s all percentages. People think that it’s easy for a 20c share to go to 40c and hence, make a 100% return. The truth is that it’s as hard as a $20 share going to $40. People think that moving 20c is easy, but moving $20 is impossible. Wrong! It’s not dollars, it’s percentages. That 20c is a 100% move and that $20 is also a 100% move. The gains are both the same.
People also seem to feel more important owning many thousands of shares rather than some tens of shares. The best example to show you that the actual price of each share (or how many shares you own) is irrelevant is as follows. Warren Buffett’s company, Berkshire Hathaway, is trading at around US$117,000 a share as at September 2007! Who wouldn’t like to own even one share of that company!? So it’s not about how many shares you own, it’s about the dollar value you invest.
The moral of this is that one should make investment decisions based on the quality of the shares, not the price at which they’re trading. A $70 share is not ‘richer’ than a 70c share. It all depends on how many shares are on issue.
This is an important point to understand. Most people believe that if Telstra trades around the $4.40 range (as at September 2007), when Macquarie Bank trades around the $80 range (as at September 2007), then Macquarie Bank is ‘richer’, or valued higher, than Telstra. However, it depends entirely on how many shares are on issue (listed on the stock market). Telstra has about 10.3 billion shares on issue, and hence, it is capitalised at about $45bn (amount of shares multiplied by the share price); whereas Macquarie Bank has shares on issue to the tune of about 271 million, which capitalises Macquarie Bank at about $21bn. So capitalisation depends on the number of shares on issue, as well as the share price. Despite Telstra’s share price being almost one-twentieth of Macquarie Bank’s share price, Telstra is worth approximately $24 billion more than Macquarie Bank (as at September 2007).