Par Greg & Andrea | May 1, 2019
Note: This article discusses the French stock market and is therefore primarily intended for English speakers living in France.
The stock market can be a fascinating but scary place. Although it rings of opportunity and significant potential profits for some, the stock exchange can represent a risky investment, whether for financial experts or those with conservative investment strategies.
A vivid example of this risk was the disastrous crash of Eurotunnel stock prices in the late 1990s. As a reminder, at that time Eurotunnel shares were generally considered to be a safe and even cautious investment; however, the price of Eurotunnel shares plummeted from a high of 8.65 € (35 francs) in 1987 to less than 1 € ten years later. As a consequence, several thousand small shareholders lost the bulk of their life savings, and the debt-ridden company found itself on the brink of bankruptcy.
That said, the success of the Eurotunnel under the English Channel is undeniable today – and after restructuring its debt in 2007, its share prices got a second wind, reaching about 12 € at the time this article was written.
This episode, like many others (Vivendi under the leadership of Jean-Marie Messier in the early 2000s, the Bernie Madoff scandal in the United States in the late 2000s, …) and various stock market crashes (the famous subprime crisis of 2008, …) have left indelible traces of public distrust in the stock market. However, even though stock market investments are risky by nature, it is possible for anyone to successfully participate in this world by following a few basic tips and words of wisdom.
Here are my 10 golden rules for investing in the stock market as a beginner.
1. Understand how the company works
A share of stock represents a fraction of a company’s social capital (that is, their goods and money). When you are a shareholder, you are thus in some sense a “co-owner” of the company.
The price of a stock is affected by two main types of factors:
- economic factors: if the financial health of the company is good and it generates profits, its share price will tend to have a higher value; and
- psychological factors: if investors have confidence in the company, its share price will also be highly valued (sometimes excessively so).
Since your goal is generally to buy high value stocks without overpaying, this last point is absolutely essential to understand, yet extremely difficult to objectively evaluate. If you buy shares at too high a price, you will lose in the long run, as share prices always eventually end up reflecting the intrinsic value of the company.
2. Invest only the money you are willing to lose
This rule may seem odd, and even overly cautious – but because stock market investments are inherently risky, you are never safe from losing everything.
You should never put all your savings on the stock market!
Before investing in the stock market, you must ask yourself the following question:
If you were to lose your entire stock market investment, would the consequences you face (beyond your disappointment!) include severe financial hardship that would make it difficult to pay your expenses? If you answer yes, it’s not the right time to invest in the stock market – wait for better days for your personal finances.
Finally, make sure not to invest all your savings on the stock market, and aim to diversify your investments with capital-guaranteed securities or financial products.
3. Only invest in companies you know and understand
It cannot be repeated enough: investing in the stock market is inherently risky! But the risk is even greater when you invest your money in a company you have never heard of or in a field you know nothing about.
As a personal example, I have always been passionate about cars, and I often buy specialty automotive magazines to stay informed about the latest models and technologies on the market. In doing this, I have quickly learned about the strengths and weaknesses of the French automotive makers and the cyclical nature of the car market:
- On the one hand, this market is very much in line with the economic state of the country. If the economy is good, people have confidence in the future and are more likely to buy new vehicles.
- On the other hand, this market is also closely tied to the renewal cycle of the vehicle. After all, broken-down cars must be replaced, even during economic crises. Although of course there is no hard and fast rule in the automotive market, on average people tend to replace cars every 6 to 8 years.
Thus, by observing the price of a car maker’s shares over a 10-year period, it can be fairly straightforward to guess whether the automotive market is currently in an up- or down-swing.
For my part, I had the opportunity to buy shares of PSA in 2014 when they were selling for about 10 €. A graphical analysis of this company and the announcement at the time of the new CEO, Carlos Tavares, led me to hope that its value would increase in the coming years. I sold my PSA shares in 2017 at a price of 20 €, and even if its value has since continued to increase (it was around 23 € at the time this article was written), I think this turned out to be a very good investment (100% in 3 years is not too bad!).
Invest in what you know and understand – it’s the golden rule!
4. Invest in only a limited number of companies
This rule directly follows that mentioned in rule 3 above. When you start trading, you first need to define a viable investment strategy. Such a strategy by nature requires you to regularly keep an eye on the companies you have chosen. However, as a beginner it is simply impossible to adequately follow the latest news or financial results of more than 5 or 10 companies.
In the end, if you do not follow this rule you risk investing in a company that you do not understand and making a poor assessment of the two factors affecting share price referred to in rule 1.
All you have to do is educate and inform yourself!
5. Avoid derivatives or investment funds
This rule also directly follows rule 3. As a beginner, do not invest in derivative products (turbo, warrant …) or markets that you do not understand (emerging markets, foreign markets …). These products / markets can be extremely volatile and can make you lose a lot of money in a very short time. Since the mechanisms of these products / markets are complex, they should be avoided for beginners.
Another good idea is to avoid collective investment schemes, such as a mutual fund or SICAV (an open-ended collective investment fund). In most cases, you do not know exactly which companies or financial products make up the portfolio of these investments. It’s like placing your trust in someone that may or may not share your investment strategy. Never forget that a financial institution has its own objectives calculated across all of the portfolios that it holds.
For my part, if I am to lose money in the stock market, I would rather it be my own fault rather than that of an investor that I do not know. This allows me to understand precisely what happened, and especially to learn from my mistakes.
Invest in what you know and understand – it’s the golden rule!
6. Understand the difference between cyclical and defensive stocks
This difference is important to know when identifying the companies in which you want to invest.
A cyclical stock corresponds to shares of companies whose financial results are very sensitive to economic fluctuations. This is usually the case for companies operating in the automotive, real estate, and major industrial and domestic equipment sectors. A defensive stock corresponds to shares of companies whose activities and profits are relatively unaffected by economic fluctuations, for example those providing basic services (water, electricity), food, and other basic products.
Once you have understood these differences, you can dig deeper by following economic and financial news articles as well as the annual reports of the companies.
7. Choose a long-term investment
If you start following the stock prices of certain companies, you will find that they are very volatile and tend to react to any new economic news (good or bad) as well as new policies and current events (for example Brexit, yellow vest protests, …).
No matter what revolutionary statistical tool a broker can provide, predicting short term market movements is absolutely impossible!
Be patient and pay attention to the fundamentals of the company. The price always ends up reflecting the intrinsic value of the company. Never make a decision in the event of a sharp rise or fall – keep calm and carry on!
8. Look into dividends in addition to stock prices
The benefit of an investment in stocks can come from two forms:
- capital gain, that represents the increase in the company’s valuation; or
- dividends.
A dividend represents the income (share of profits) paid by the company to its shareholders. Although it is best to bet on a company whose share price will (hopefully!) continue to increase, dividends also represent an important factor to take into account.
Indeed, some companies may have a mediocre share price but pay out regular dividends. Dividends allow the investor to reliably earn a sum of money each year that can be reinvested in the stock market or invested in another financial product.
You can earn money on the stock market both as a result of a capital gain realized on the sale of a share and as dividends paid by the company.
9. To invest economically in the stock market, use a specialized online broker
Although the largest online banks are particularly competitive in terms of prices for conventional banking (free credit card, higher overdraft limits, lower overdraft fees, …), they do not usually offer the best services for stock market trading.
Instead, make use of online brokers that are specialized in this field – you will avoid paying account fees, and brokerage fees (fees charged by stock market intermediaries when buying or selling securities) tend to be particularly low.
When calculating the profitability of your stock market investment, these fees are not to be neglected (just like the tax on financial transactions), because they systematically increase the cost of a stock you want to buy or sell. In the latter case, the capital gain that may be acquired can be greatly reduced in the event of significant fees.
| Tip n°1:
If you plan to invest in the stock market in the near future, you should open a PEA and/or a PEA-PME account now (even without putting a dime in them).
Only these two types of accounts allow for a tax exemption of capital gains if funds are kept in the accounts for 5 years. Paid dividends are also exempt from taxes. However, any withdrawal of money during a period of 8 years starting from the date the PEA or PEA-PME were opened results in the closure of the account. After this 8-year period, it is possible to withdraw money without closing the account, but no further payment is possible.
Tip n°2: If you already have a PEA or a securities account in another bank, do not hesitate to have it transferred to the online broker of your choice. Indeed, transfer fees are often covered by the welcome offers of these brokers. Depending on the broker chosen, you may retain the seniority of your PEA account. |
10. As for any investment, miracle profits do not exist on the stock market
In the long run, the price of a stock reflects the real health of a company; in spite of all of its intrinsic qualities, a company simply cannot have a double-digit growth rate for eternity.
For long-term investing, favor a company with a low but steady growth rate (and preferably one that pays dividends), rather than one with a potential for strong growth but high volatility.
Your blood pressure will thank you!
Remember
At a time when secure investments like Livret A or the LEP are making investors lose money because of lower interest rates than inflation, investing money on the stock market can be a good idea. Nevertheless, it is necessary to apply the two main rules of caution, namely:
- Investing in the stock market is risky: you should never put all of your savings in it;
- Investing in the stock market can be complex: you should bet on companies that you know and understand.
Finally, one last tip before taking the first big step: make sure you understand the jargon of stock exchange orders before buying your first shares of stock. It is important to understand the different types of orders available in order to avoid expensive mistakes in terms of transaction costs; you can find a short article with explanatory examples here.