Most advisers reckon £2,000 is the smallest sensible amount for a single investment, though many recommend £3,000. It is possible to deal in smaller amounts at one time but it puts up an extra barrier to making a return: stockbrokers set a minimum price on transactions and the dealing costs can overwhelm the profit from the transaction. If you are dealing in a small company’s shares that have a wide price spread (the difference between the buying and selling price) the threshold for potential profit is raised still further. And there is also a government tax on dealing (see page 102).
For example, if the dealing cost is £20 for a £500 parcel, the share has to rise by more than 8 per cent just to break even, bearing in mind the likely dealing spread. That means a share standing at 220p would have to rise by over 18p before the investor saw any benefit. It can happen, but it is just stacking the odds against yourself. However, competition among stockbrokers is increasing with the numbers of sites on the internet growing daily, so the cost could start coming down and with it the minimum economic investment.
Mark Twain said there was nothing wrong with putting all your eggs in one basket, but watch that basket. That is unlikely to work for the stock market. Scrutinize a company with all the attention possible, analyse its figures and read all the reports available and, despite all the favourable indications, it can still decline, to general surprise. Sudden external changes can overwhelm sound businesses, and inept managers can so fail to keep track of what is happening under their noses that nobody outside notices either until profit warnings show the depth of the problems, or takeover predators or the liquidator move in.
For safety, therefore, one needs to spread the risks over a number of companies. A decent portfolio even for a relatively small investor would contain at least 10 companies. That is the eventual safe haven however, and it does not mean everyone must start with at least £20,000 going spare for it to be worth even thinking about the stock market – it just means these are the sensible requirements to reduce the much-publicized risks. Remember the main aim of investing is to get a decent return for an acceptable risk. With one share the risk is greater, but the more companies’ shares you own the less chance there is of your entire stock market holding suddenly collapsing to nothing. It is possible to build a range of shares over the years; indeed most advisers reckon it is a good idea to keep a little float of available cash to take advantage of opportunities.
A really rich investor can put money into property, fine art, venture capital, currency funds, etc, and spread equity investment all round the sectors and the world. That way all risks are hedged. For most of us, offsetting one or two of the dangers is the best we can hope for. The two most obvious risks are that the money will be eroded by inflation, and that all of it will disappear through corporate incompetence.
It is a general rule that the lower the risk, the lower the return – which generates its own obvious warning that if somebody is offering mouthwatering returns or even a profit that seems markedly above comparable destinations for your cash, you may rely on it: there is a catch. The converse also holds true: the higher the risk, the higher the potential reward. Invest in a single share and if you struck it lucky the investment can multiply many times in a single year, and for some people with an appetite for danger that offsets the risk that the company could fold, taking every penny of the investor’s money with it. In general this is to dramatize what really happens – in practice it is far more common for the share you own neither to burst through the roof nor crash through the cellar but to pootle along in the doldrums for months or even years, producing little movement in the price.
That £20,000 may look a formidable sum – especially if one thinks about it as the minimum safe level of holding – but set it against lifetime earnings of over £1 million for even a relatively lowly-paid household and it begins to seem a little more doable. On the other hand, if the total costs listed here and the amount needed to provide a reasonably safe income seem out of reach, there are less daunting alternatives, though still with a link to the benefits of the stock exchange, such as investment or unit trusts (see Chapter 3).
Source: Becket Michael (2014), How the Stock Market Works: A Beginner’s Guide to Investment, Kogan Page; Fifth edition.
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