Part Four: Investing

Chapter 14. Starting Out

First – study yourself

It can be a daunting prospect to invest in the stock market for the first time so it is very important to do your homework. Start by studying yourself.

Only you know:

· what you can afford to invest

· what risks you want to take or can afford to take

· whether you want to invest for the short or long term

· whether you want a steady stream of income to live on or to store up wealth for the future.

Before you invest, sit down with a pen and paper (or some spreadsheet software) and note your income and all your outgoings, including food, clothing, entertainment and holidays as well as any mortgage payments, utility bills and any monthly instalments on furniture or electrical appliances.

You should consider owning your own home if you are renting. Like shares, property values can fall but they also rise over the long term and you have to live somewhere.

Most families these days own a car. If you do, you should allocate some cash towards the next one.

Indeed, you may feel more comfortable with some of your cash invested in liquid assets – that is, money you can get hold of in an emergency at little or no notice, such as savings in a building society account.

Shares are liquid in that they can be sold quickly in the stock market but there is always the danger that you find yourself having to sell just when the market is depressed. Keeping a pot of cash earning some interest but readily available gives you the leeway to hang on to shares that you believe will gain value and can then be sold at a higher price.

If you decide, despite reading this book, that you need the help of a financial adviser you must lay your soul bare. The adviser needs to know all your financial circumstances and your investment aims in order to give you the advice that suits you.

In the following chapters we will look at different investment strategies but first there are some general points worth noting.

Keep yourself informed

You don’t have to sit at your computer screen watching share price movements all day. Leave that for the day traders, the people who make a living by buying in the morning and selling a few hours later.

You should, however, keep abreast of what is going on. Information is freely available in newspapers, specialist magazines and financial websites so there is no excuse for burying your head in the sand.

Earlier in the book we saw that companies are required to issue at least two announcements each year: the interim results and the full-year results. These are usually accompanied by an indication of how trading is going.

In addition, most companies now issue quarterly trading statements to fill in the gaps between the half-yearly results, so you are less likely to find that disaster has struck out of the blue.

Factors that affect share prices

Share prices are on the move throughout the trading day. Those of the largest companies such as BP and Vodafone will change moment by moment, as buying and selling ebbs and flows; those of the tiniest companies may move only sporadically and may go for several days without a change.

The main impetus for share price change is supply and demand. When buyers pile in, shares inevitably go up; a flood of sellers is bound to depress the market.

However, buying and selling pressure is the symptom rather than the cause. We need to look at why it is sometimes predominantly buyers and sometimes sellers who are out in force. We should note that on some days practically the whole market moves in one direction, while at other times it is just particular sectors and sometimes just individual shares.

Even when the market as a whole is moving in one direction, perhaps over a prolonged period, some shares will buck the trend. During the three-year bear (i.e. down) market in 2000–2003, when Footsie shares on average lost more than half their value, oil explorer Soco and financial broker ICAP both saw their shares increase by more than 400%.

Market movements

Reasons why the market as a whole moves

1. There is new UK economic news such as inflation figures.

2. Markets around the world are moving in a particular way and London joins the trend. Shares in the UK are particularly influenced by large movements on the New York Stock Exchange, as the US is the world’s largest economy.

3. The market has moved strongly in one particular direction and investors take profits or look for bargains.

4. The world economy takes a turn for the better or worse.

Reasons why a sector moves

1. There is news specific to that sector: for instance, a rise in oil prices will hit the shares of transport companies faced with higher fuel bills.

2. Sales of goods and services in one sector are affected by changes in consumer behaviour, such as the switch from high street shopping to buying on the internet.

3. Companies in a particular sector are expected to be involved in takeover activity.

Reasons why shares in a particular company move

1. Sales and profits are better or worse than expected.

2. The company announces that it expects to beat or fall short of analysts’ expectations.

3. A rival company is winning its business or is struggling to keep its own share of the market.

4. Rumours about the company circulate, particularly if the talk is of a takeover.

5. A takeover or an approach that could lead to a bid is announced.

6. There are changes to senior management.

7. Directors buy or sell shares in the company.

8. The board changes its strategy, perhaps deciding to seek new markets, expand overseas or sell loss-making operations.

These are all logical reasons for share price movements, but it is also true that the stock market can, in the short term, be an irrational place and rises and falls sometimes seem to defy logic. Such movements are prompted by market sentiment, the general feeling in the market.

Shares may start to rise and punters leap onto the bandwagon for fear of missing an opportunity, only to fall off painfully when the bandwagon comes to an abrupt halt. Then shares may fall back sharply in what is known as a correction.

Interest rates

Why and how interest rates move

Interest rates used to be set by the chancellor of the exchequer and changes tended to come out of the blue. But one of the first things that Gordon Brown did when he moved into No. 11 Downing Street was to put the Bank of England in charge of interest rates.

The Bank has a Monetary Policy Committee (MPC) of nine men and women, comprising the governor of the Bank of England, the deputy governor, other senior Bank of England staff and outsiders appointed by the chancellor. Its task is to keep inflation within prescribed limits, currently between 1% and 3% as measured by the Consumer Price Index.

Interest rates tend to run in cycles, rising and falling over a period of months or years. The period of stable, ultra-low rates that followed the banking crisis was exceptional.

Mercifully for investors, the Bank tries to warn us of impending changes in interest rates and to give some idea of where we are in the cycle, so there is no reason to get caught out.

The MPC meets early in each month and members vote on whether to raise rates, keep them as they are or reduce them. The majority vote prevails and if necessary the governor has a casting vote. The decision is announced at noon on a Thursday, together with the voting figures and an indication of the members’ thinking.

Changes are normally a quarter point in either direction, although individual members have occasionally voted for half point changes and sometimes larger movements do happen. Minutes of the meeting, including voting figures, are issued later in the month. The Bank also issues a quarterly report, so there are plenty of clues as to which way the wind is blowing.

In broad terms, interest rates are likely to be raised when inflation rises above the 2% midpoint in the target range. Higher interest rates make debt more expensive, demand for goods is curtailed and consumers start to get twitchy. It becomes more attractive to save than to spend.

Interest rates are likely to be lowered when inflation falls below the 2% midpoint. Lower interest rates make debt less expensive, so consumers are more inclined to go out and spend. Saving becomes less attractive.

These general rules were cast aside when stimulating an economic recovery after the credit crunch took precedence over controlling inflation – but they still apply in principle.

The effect of interest rates on share prices

Share prices are affected by changes in interest rates:

· rising interest rates are bad news and send share prices lower

· falling interest rates are good news and send share prices higher

Several reasons why higher interest rates are bad for shares are:

· if demand for goods and services falls (as consumers have less cash to spend), then companies will make reduced profits

· the pound becomes more attractive for foreign investors to hold, so sterling rises on the foreign exchange market and British goods become more expensive abroad, so exports are affected

· companies that export from the UK or have operations abroad find that their profits are reduced when foreign currency is converted into more expensive pounds

· investors find it is more attractive to invest in bonds or even keep their cash on deposit because they are now being paid a higher rate of interest

· investors who take the risk of borrowing money to buy shares find it more expensive to do so

· preference shares fall in value because the fixed rate of interest becomes less attractive

Rising interest rates are referred to as a tightening of monetary policy.

When inflation falls, the Bank of England can relax or ease monetary policy by cutting interest rates. Now the factors we considered when discussing rising interest rates work in reverse. Consumers spend more and save less, which is generally good for the profits of UK companies. Bonds become less attractive, while borrowing money to buy shares offers a better hope of producing a decent profit.

Thus falling interest rates tend to push share prices higher.

Facing reality

We should not panic if shares in a company fall just after we have invested in it. We should reconsider whether the reasons for our purchase still hold. If we are still confident of the investment case, the lower share price actually makes the company more appealing because the shares are now more of a bargain.

However, the hardest thing for any investor to do is put hand on heart and admit: ‘I got it wrong’. Even hardened professionals cling to shares as the price falls relentlessly, in the vain belief that their precious investment must eventually prove justified.

None of us get it right all the time and sometimes you will have to bite the bullet and sell at a loss.

Some investors set a stop loss. They fix a price at 10% or 20% below the price at which they buy a particular share, and resolve to sell if the share falls to that level. In that way any losses are limited.

There is no magic level at which you should set your stop loss. Set it too high and you will sell out before you have given the shares a real chance to perform. Set it too low and you risk a heavier fall if you really have picked a loser. You need to decide what your attitude will be before you invest.

If you find an error or have any questions, please email us at Thank you!