Whats the biggest mistake a newcomer to investing in shares makes? Well, possibly the biggest is seeing it all as a get-rich-quick scheme rather than taking the slow-and-steady long-term approach that is an almost certain winner and that problem is compounded by over-trading and ending up paying far too much in charges.
Suppose youre buying and selling in 1,000 lots, and youre using a stockbroker who charges a flat 10 per deal. Whenever you buy and subsequently sell a shareholding, youll be paying 10 per trade plus 5% stamp duty on the purchase. And on top of that, you also have to beat the difference in the buy and sell price for the stock (known as the spread). With a heavily-traded FTSE 100 company the spread is often negligibly low, but for the kind of smaller companies usually favoured by frequent traders its often a couple of percent and with some very small and thinly-traded companies it can even be in the tens of percent.
Anyway, with a 2% spread so youd be 45 down on a buy-then-sell deal before you can make any profits (two trades at 10 each, plus 5 stamp duty, plus 20 in the spread). So youd need a 4.5% gain in the share price just to break even on your 1,000 investment.
Lets see a couple of examples
Suppose you start off with a modest lump sum of 1,000, and then you can afford to add an extra 100 a month. I reckon you stand a realistic chance of getting annual returns averaging around 6% (with so many dividends alone yielding 5% and better out there). Now, even if you end up paying 1% in costs per year (and thats pessimistic if you look for companies you want to hold for many years, youll incur just one charge per investment).
After 20 years, youd have invested a total of 25,000 and would be sitting on a pot worth more than 43,000 after charges a profit of 18,000!
But how about our frequent trader, who invests in smaller companies, and buys and sells once per year per holding, incurring 4.5% in costs per year? Well, theyll only be netting the equivalent of 1.5% per year, and theyll end up with just 29,000 after 20 years a profit of only 4,000. To equal our long-term buy and hold (LTBH) approach, theyd need annual returns of 9.5%.
And if they trade each position twice per year? Theyll be paying 9% in costs and would have to achieve an annual return of 16% to equal the LTBH investor. What was it Woody Allen said, a stockbroker is someone who invests your money until its all gone? If you trade this way youll easily be able to do that all by yourself.
The lesson seems clear use a stockbroker who offers low charges, and avoid over-trading by buying shares that you want to keep for decades.
So which top five companies should you be looking for to set you up in the years ahead?
If you can find five companies paying reliable dividends, and with potential for share price rises year after year, then you’ll have the bedrock of a solid long-term portfolio.
And that’s exactly what The Motley Fool’s 5 Shares To Retire On report identifies for you — it’s completely free, so click here now and get your personal copy today.
