Why Invest in Shares?
Overview
We have taken the time to understand our current financial situation which will help us make wise decisions about our future investment goals. It is time to understand why buying shares is a good method of investing and growing your money as part of the wealth creation process.
By the time you have completed this module, you should be able to answer the following:
- Why should I invest in shares?
- What is capital growth?
- What are dividends?
Why Invest in Shares?
Shares are a tool to generate more income for the future. Most investors, even those who are conservative, want some level of income generation from their portfolio. You can choose to invest in shares so that you make the most of your current income for future goals such as:
- Sending children to college
- Buying a house or car
- Making sure you have money for your retirement
- Starting a business
- Creating a fund for emergencies
So what does the income made from investing in shares look like? The income made from investing in shares comes in 2 forms:
- Capital Growth
- Dividends
If you invested R1000 in shares and the share price was R100 a share, and the price of the shares goes up to R110, you would have received an increase in value of your shares of 10%. However, if the share price went down to R90, your shares would have decreased in value by 10%.* It is important to remember that investing in shares does not guarantee income/profits as it all depends on what the share price will be when you sell.
*Brokerage costs and taxes are not included in these examples
Capital Growth
Simply put, capital growth is the difference between the amount you paid for your share and its current value. So, if you bought a share a year ago and paid R100 for it and today this same share had gone up in value to R150, the capital growth would be valued at R50.*
You are able to determine whether you have made a profit or a loss on your investment by subtracting the price you paid for your share from the sale price at which you sold it. In the above example, you would have made a R50 profit.
A profitable trade is one where you buy a share at a lower price than what you sell it at. When you buy shares, a profit is only made when you sell the shares at a higher selling price.
*Brokerage costs and taxes are not included in these examples
You are also able to calculate the percentage return of your shares by dividing the profit or loss you make at the sale of your shares by the initial price you bought it for.
From our previous example, that would look like:
R50 / R100 x 100 = 50%*
If you owned five of these shares, then this 50% return would mean that you made a profit/ income of R250, calculated as follows:
*Brokerage costs and taxes are not included in these examples
Dividends
Dividends are how a company rewards or pays out a portion of its profits to shareholders/ investors. It is important to note that not all companies pay dividends, even if they are profitable. They can choose to do several things with the profit made such as:
- Re-invest it into their business
- Pay off debt
- Pay a portion of these profits to their shareholders (i.e. dividends)
Companies pay out dividends either once or twice a year, should they pay it out, after their annual or interim results. It is the company board's discretion whether to pay out dividends to shareholders and how much to pay in dividends. For instance, if I invested R1000 at R10 each with 100 shares, it pays out 20c per dividend and I would get R20.*
*Brokerage costs and taxes are not included in these examples
Up next