Sonia Rehill hosts episode 2 of Ask A Foolish Question.
You can download or listen to this podcast here.
Sonia:
Welcome to Ask A Foolish Question, The Motley Fool's brand-new podcast dedicated to help answer all your investing questions. I'm Sonia Rehill, and joining me today is David Kuo, to share some of his investing wisdom. Welcome back, David.
David:
Thank you. I am back – I thought I wasn't going to make it back, but I finally have.
Sonia:
You're back by popular demand.
David:
Is that right? Okay!
Sonia:
Yes!
David:
Clearly, my emails are working.
Sonia:
So, David, we have been inundated with questions since we launched this podcast two weeks ago. Let's kick off with my first question from James. He's 23 years old, and is paying off some student debt, and he wants to know how much money he needs to start investing.
David:
Okay, now some people say that, if you have debt, you shouldn't really be investing, but I would classify student debt as being good debt, because when you take out a student loan, hopefully it will improve your earning potential as you go through time, so student debt is a kind of good debt. But as far as, when you can start investing, or how much you need to start investing, I would first of all put some money to one side. This is what I call a safety net -- this is a comfort cushion of money that you have put to one side, in case something terrible goes wrong. So have that in place also, and then after that you can start thinking about trickling money into the stock market, and often you don't really need huge amounts of money. People have this idea that you need thousands upon thousands of pounds in order to start investing. You could do so with just £30, trickling it in every month into a stock market index tracker, and that will kick start your investing.
Sonia:
Well, there you go -- you can start investing for as little as £30.
David:
£30, right -- you don't really need an awful lot of money to do so.
Sonia:
How do you build a basket of dividend-paying shares? Where do you begin, David?
David:
Okay, let's first of all start by having a look at dividends. Dividends are a share of the profits that a company makes which it pays out to investors. So what you effectively do is, you buy these shares in these companies, they make a profit, and they say, "Right -- here is a small percentage of what we make. We're retaining some of it because we need to grow our business", and that is called dividend investing. What you really need to do is to look for companies that have a previous history of good profit growth, because if they don't make any profits, they can't pay you any dividends. So look for companies that have good profit growth historically, and have been able to pay dividends, and those are the kind of companies you want to focus on. So I would start first of all with the FTSE 100, because these are solid companies, these are good companies, and these are companies that have traditionally paid out a significant amount of their profits to shareholders.
Sonia:
Do you think it's more important to have dividends, or for the share price to grow?
David:
Okay, now this is one of these questions that infuriates people, and here at The Motley Fool we have this service called the Share Advisor. We have one group of advisors who believe that dividend is more important than pure growth. Then on the other hand, we have the other advisors, the other analysts, who say that it is more important for the shares to grow, and they're not that bothered about dividends. I, on the other hand, believe that dividend is important, because I believe, and am one of these people who says, jam today is more important than jam tomorrow. So if a company has profits, rather than for the company to retain those profits and grow, I want them to give me some of those dividends, so that I can grow my portfolio.
Sonia:
This is an intriguing question: what is the best day of the week and time of day to buy shares? Now, I Googled this, David, and the first page that popped up mentioned a '10 am rule' for stocks and options. What's that all about?
David:
Okay, now the 10 am rule is more for traders than it is for investors, because I mean, all sorts of things go on before 10 o'clock in the morning. I, on the other hand, will say, yes -- you don't really want to buy shares early in the morning, because the market is particularly thin. In other words, the spreads -- this is the difference between the buy and the sell price that brokers will quote you -- is particularly wide first thing in the morning. Now, let's say, for instance, I want to buy Vodafone shares. Now, if there aren't that many people selling Vodafone shares first thing in the morning, then what will happen is that the broker will say, I will charge you a lot more to sell you those Vodafone shares, because ultimately he has to go out and find those Vodafone shares, and he isn't entirely sure what's happening. So I would say, the best thing to do is to leave it until later on in the day, when the market becomes fuller, when people start waking up, when people start to dip into the market, then that is the time to start buying the shares. What you can do, however, if you are an early bird, and you want to buy those Vodafone shares, you can set a limit price. You can say, I don't really want to buy Vodafone shares anything more than say £1.75. Then you can set that limit and, of course, your broker will have to adhere to that, and he cannot buy you those shares that are costing more than £1.75. So, as far as the best time of day to buy shares, I would say any time of day is good, as long as you are able to set the price that you want to buy those shares at.
Sonia:
And is there a best day of the week?
David:
Every day of the week is a good day of the week for me to buy shares. What really matters most is the company itself -- knowing what you are buying, and why you are buying it.
Sonia:
Well said, David. So earlier today, I asked Nate Weisshaar, a senior analyst on The Motley Fool Share Advisor service, to explain some investing jargon that's not as obvious as buy, hold and sell. Nate, can you explain what we mean by outperform and underweight, please?
Nate:
Well, first off, I don't think I would ever use those ratings, but some analysts use them as a more relative, or a bit of a softer call. Underweight is a nice way of saying they don't think a company's going to do as well as their peers, or the market, and so essentially it's a sell call. But the reason you see analysts using these is to get around the fact that they don't want to say sell, for various relation reasons. You tend to cut off communication lines if you tell a CFO that his company's a sell. So an underweight or an underperform is a nicer way to say, you don't think a company's living up to the competition. It's really just a way to blur the lines, and it's also easier for an analyst to squirm out from under an underperform than a definite sell call. So it's really just a way to dance around the issue.
Sonia:
Are there any other phrases or confusing investing terms that brokers or analysts use out there?
Nate:
I'm sure there are numerous ... one of the ones that has confused me lately was, I saw an analyst change recommendation from buy to add, which made no sense to me. I can't really tell what that means.
Sonia:
Would that mean, buy more?
Nate:
I assume that's what he was trying to get at, but add sounds just as good as a buy to me.
Sonia:
Well, thank you very much. David, do you have anything to add to that?
David:
I do have something to add to that, and that is simply that brokers are unwilling, very often, to give sell recommendations, because they don't like the idea of infuriating management, so they don't like giving sell recommendations. So what they tend to do is to come up with a load of jargon that is kind of confusing for the private investor. Let's have a look at something called a hold. A hold just simply means that you are holding the shares, and you are not either selling or buying those shares. Then they come up with things like, a firm hold, a weak hold. These kind of things sound more suited to the World Wrestling Federation than it does to stockbroking. Then you have things like neutral, which is a kind of a hold, but what does a neutral actually mean? Then you have things like equal weight, accumulate, add, avoid -- all of these things are nonsense. What you really want to know is, do you want to buy the shares? Do you want to hold them? Or do you want to sell them? Just forget about all this other broker babble that comes along, and is entirely confusing for private investors.
Sonia:
Onto my next question -- we've received a few emails about investing in old age. David is interested (this is not you, David) -- David is interested in opening a stocks and shares ISA, but he's been advised to leave shares alone, as they require time which he does not have. He asks if you agree, and if so, why isn't this explained by financial services?
David:
Right, what I do say to David, my namesake, is that the one thing you need to be very, very wary of is inflation. Now, inflation affects older people as well as it affects younger people, and what you really need to be aware of is, what are you doing with your money in order to cope with inflation? If you're not beating inflation then, of course, the pot of money that you have will shrink over time. Yes, I agree that, if you are of a certain age, then you need to be a little bit more cautious, but that doesn't mean you avoid the stock market totally, because the stock market is one of two asset classes that is able to beat inflation over the long term.
Sonia:
What proportion of his cash should he hold in equities?
David:
Okay, right -- there is a very simple rule, and it's simply called the Rule of 100. In other words, you take 100, and you subtract from that your age. Essentially what it really means is that, let's say you are a person who is 40 years old, so 40% of your portfolio should be in cash, 60% in shares. You take 100, subtract from 40, and that leaves you 60. In other words, 60% of your portfolio should be in shares. Now, as you get older, less and less of your portfolio should be in shares. So let's say you are 90 years of age, right. So 100 minus 90 gives you ten so, in other words, 10% of your portfolio should now be in shares; 90% should be in cash. That is the kind of rule of thumb, and the reason why it's done that way is so that, as you get older, you really haven't got a great deal of time, if the stock market were to plunge. So therefore, you want less of your money in shares, and more of it in cash.
Sonia:
Great. Norman also mentions that, at 88 years of age, investing is a problem, and long term is meaningless. However, he does have some investments. His portfolio consists of shares, mainly utilities. He has numerous old unit trusts, PEPs and ISAs, the odd investment trust and he has cash ISAs and various private pension annuities. He is concerned that his portfolio is at risk, due to the current worldwide and local financial problems, his investing strategy is income and preservation of capital, but he's not sure if that's enough. Is he missing anything?
David:
Well, I think, as far as Norman is concerned, he has done exceedingly well. I don't know how big his holdings are in all of these companies and all of these investment trusts that he's got, but what he has done is to build up a portfolio over time. Now, many of the shares, and the investment trusts that he has, will be paying him income, will be paying him dividends. What he really needs to do is to ensure that those dividends are constantly reinvested. I know he's 88 years of age, and he really should be enjoying life. So he has two choices with regards to that income: he can either draw it down, in other words, draw it off from the portfolio, and spend it, and enjoy his life, and anything that is left over, he can always reinvest back into his portfolio, to make it grow. So Norman, you shouldn't be too worried about what is going on in the world right now, and as far as preservation of capital is concerned, I think most of the companies that you are invested in are solid companies, and they will withstand any kind of shock that is likely to happen in the global environment.
Sonia:
I hope you feel reassured with that answer, Norman. Next, we have an email from Jonathan in Seattle. He asks what benefits are there to investors, if there are any, when a company's stock splits? Now, there's been quite a bit in the news about Google, and I think Coca-Cola are recommending a stock split. Would you mind firstly explaining what a stock split actually is, David?
David:
Okay, right -- a stock split is very, very simple to understand. Let me take this £20 note, I've got a £20 note, and I'll give this to you. In exchange for that, give me two £10 notes. Right, thank you. So you've got the £20 note, I've actually got two £10 notes -- have I made any money out of the £20 that I've given you?
Sonia:
No.
David:
None whatsoever. So what I've done is to split my £20 note into two £10 notes, a two-for-one split, and that is essentially what happens, as far as shares are concerned. A company believes that its shares have risen to such a level that it makes it very difficult for private investors to buy the shares, so what it does is, it splits the shares. So a two-for-one split means that the share that you own at the moment now becomes two shares, and each share is worth half the amount that the share was before it split. So, essentially, you haven't made money, you haven't lost money. So what's in it for investors? I don't think there's anything huge for investors there, except, of course, it becomes more liquid. In other words, there are more shares now in circulation, so that if you want to buy a small portion of the shares, it is easier. If you want to sell some of your shares, it is easier also. So let me give you an example: let's say I have a share that has risen to £1,000 a share. Now, I'm holding onto this one share that's worth £1,000, and I want to sell half of it -- I can't sell half a share. Even though I just need £500, I can't sell half a share. I have to sell the whole share, or nothing at all. So it makes it very difficult for me to trade my shares -- even if I wanted to sell half of it, it's impossible. So by splitting the shares, now it says that there's a two-for-one split, and I still have £1,000 worth of shares, except now I have two shares, so I could sell one of them if I wanted, and take that £500.
Sonia:
So there's nothing in it for the company?
David:
That's a difficult question to answer. Up to a point, I would say, no, there is nothing for the company, nor is there anything for the private investor. What it does do is to create more shares in the market, so that more people can buy those shares, so I suppose in the sense that more people can own shares in that company, and it is good for that company, because it has more shareholders. But you also mentioned two companies there, Sonia -- you mentioned Google and also Coca-Cola. Now, there is a big difference between the share splits at Google and Coca-Cola. What Google have done is to say, right – if I use the analogy of the £20 note again, this time I give you £20, but in exchange for the £20, you now give me two £10 notes that are different: one £10 is freely traded, I can spend it anywhere I want to; but the other £10 note has restrictions on it, and those restrictions say that I can only spend it in this particular area. Now, what has effectively happened is, I've given you one £20 note, and in exchange for that you've given me two £10 notes that are different. Now what Google has done is, it's split the shares, but what it has effectively done for shareholders is to say, you now have two shares, one of which has a voting right, the other one doesn't have a voting right. So that therefore means that --
Sonia:
But everyone has a voting right?
David:
No, they don't.
Sonia:
Because it's split?
David:
Right, you are right, Sonia, but what they have done with these particular shares is to say that we are diluting the power that you have with this share in your hand, so that when you do turn up at an AGM, and we have a motion that needs to be voted by shareholders, if you are holding onto these non-voting shares, you don't have a right to say what is going on in the company, so it is grossly unfair on those people who are now holding onto these shares. Monetarily, there is no difference, but in terms of the power you have, and how the company is to be run, there is a difference.
Sonia:
So how would a company decide on who has voting rights and who doesn't, in this case?
David:
Well, this is now subject to an investigation over in America, because some of the shareholders are saying, we have been duped out of our rights as a shareholder, and this is something that may have to go through the courts to see whether or not Google has this right in order to do that. Now, onto Coca-Cola -- Coca-Cola is a much easier situation for us to understand. The Coca-Cola share price at the moment is about $75 a share -- that works out to be approximately £50 a share. Now, what Coca-Cola has said is that it expects sales to double over the next ten years. If the share price were to follow the sales that the company is expecting over the next ten years, it means that in ten years' time, Coca-Cola shares could be worth $150 a share – that's £100 a share. Now, what Coca-Cola is trying to do is to pre-empt the rise in the share price by saying, "Let's have a stock split now". In order words, "Let's split this $75 stock into two stocks, so that they're each worth approximately $38 a share, so that, when it does double in value, it will go back up to $75 again in about ten years' time". So what it is doing, it is pre-empting the rise in the share price by making it more affordable today. I mean, can you imagine, in ten years' time, if somebody had to stump up $150 just to buy one Coca-Cola share -- it would be almost impossible for people to do.
Sonia:
Thanks, David. That was a very good explanation. For our final question now --
David:
Already?
Sonia:
Yeah, it's an email from Roger. He is saying, investors buy shares in a company in the hope that they get something more back later, ie dividends, or share value growth, which hopefully exceeds the rate of inflation. Does it matter to the company, what happens to its share price? After all, they have got investors' money from the initial share launch, and are not obliged to buy them back at any time.
David:
Okay, so as far as Roger is concerned what he wants to know is, what difference does it make to the company? He's already got your investment -- does it matter whether or not those shares are worth higher or lower at any point in time? Well, the first thing is, every company wants its share price to rise, because a rise in share price means that the company is doing well. So many of the managers in those companies would be saying, I am measured by my performance, and my performance is reflected by the share price. So if my company makes more profits, the share price goes up, so it means that I'm doing a good job. So in that sense, yes -- the company wants its share price to rise over time, because otherwise it's not doing its job properly. Now, the other reason why companies want the share prices to rise is because they use those shares as a form of currency. If my share price goes up, it means that I as a company, at some later date, I could issue more shares at a higher share price, and use those shares for buying other companies. So it is almost like an acquisition tool -- it is like a currency that they can use, and the higher the share price, the more power the company has.
Sonia:
Thank you, David. You've provided some great answers there to some really interesting questions. I think we might get you back on again.
David:
Really?
Sonia:
Yeah, I'll speak to my producer, and to your agent.
David:
Well, I might have to check my diary, Sonia.
Sonia:
Ah, ha, ha -- look at you! You're turning into a right diva!
David:
Turning into one? I think I already am one!
Sonia:
Well, you said it! Now, if you would like to submit a question, you can do so by emailing me at foolishquestions@fool.co.uk, and if you're new to investing, you can read our Investment For Beginners series, and download a free report, What Every Investor Needs To Know, at fool.co.uk/questions. Thanks for listening and, until next time, happy investing!
