If you’re a newbie investor, it’s essential to get clued-in on the basics of the share market.
And one of the major fundamentals that beginner investors should get their head around is market risk and how much appetite you have for it.
This is important knowledge to build up, because while investing can be an exciting and prudent way to create wealth, it’s not risk-free.
Even if a stock looks like a sure thing, there’s always a chance you could lose money — say, if the company gets into difficulty, if the economy hits tough times, or if there’s a big market downturn. (Just to name a few!)
So, while you can never rule out losing money on the share market, investing — for beginners and pros alike — always involves finding smart ways to put yourself in a strong position. Here’s some things you need to know.
Consider defensive stocks
The big thing with defensive stocks, sometimes known as non-cyclical stocks, is that they tend to perform well irrespective of the wider health of the economy.
That’s because the companies behind defensive stocks are typically involved in essential items and services, so demand tends to hold up.
Examples of defensive stocks include healthcare, telecommunications, and utilities stocks such as water, electricity and gas.
If you’ve got a stomach for risk, you may want to consider cyclical shares. These stocks tend to be more aligned to the fortunes of the broader economy.
What that means is that during economic upswings these stocks tend to go up, but when things go south, these stocks tend to go down as consumers close their wallets and focus on essentials.
Examples of cyclical stocks include real estate, retailers and financial services stocks.
Smaller stocks are generally riskier
When it comes to stocks in smaller companies, often known as small- or- micro-caps, a savvy investment can lead to great rewards. But with great reward, comes great risk. (And vice versa.) Any time you invest in a smaller company, you’re usually taking on a higher risk.
In many cases, small-cap stocks haven’t been trading for as long as mature companies (some of which may have been in business for decades). This makes small-cap stocks less reliable bets, because their business model isn’t yet proven.
Another issue is that smaller companies generally find it harder to access and raise capital, which can make cash flow a problem and cause troubles in business cycle downswings.
Finally, there might not be much information available related to a smaller company, so it could be hard to assess the company, its finances, and future performance.
Instead of riskier small-cap stocks, you may have better luck with blue-chip shares. For instance, you could look at the S&P/ASX 200, a list of Australia's top 200 companies (by market cap). They tend to be long-running, stable stocks ideal for investors looking for steady returns with relatively less risk.
Don’t jump in fresh
Remember, if you're totally brand new to the share market, it can pay to get the lay of the land first. Make sure to arm yourself with all the information you need to make a more informed decisions when considering investing, especially in the high-risk world of shares.
In addition to reading some basic investing books, you could consider joining an investing group, visiting an online investing forum, doing your own research or even enrolling in an investment course.
When it comes to doing your own research, some material you could look at would include annual reports, company reports, research reports and consensus.
As you should do with anything that relates to your personal finances, always consider your options carefully before you enter the market and make sure to get financial advice.