Daring to tread the stock market minefield

Global stock markets have taken a battering in the past two years, so investing in equities is no longer for the faint-hearted…

Global stock markets have taken a battering in the past two years, so investing in equities is no longer for the faint-hearted. But with good advice, anyone with €10,000 to spare could do worse than take a punt, writes Una McCaffrey.

You know for sure that something has been happening for too long when people start running out of words to describe it. Thus it is with the stock market: the falls have been so extensive and so repetitive over the past year or so that commentators have more than used up their lexicon of plummets, plunges and, worst of all, collapses. If things don't get better soon, the public will have died of boredom long before their money has run out.

It is undeniably sad that the once-mighty market has been reduced to a position where most speculation concentrates on how low it can go. Just a couple of years ago it was the opposite, with delirious shareholders watching to see which ceiling their chosen stock was going to break through next. For big and small investors alike, the period since the late 1990s has been the ultimate in tumultuous rides.

When it comes to investing in stocks, investors at the more modest end of the scale are faced with two broad choices. Either they can try to scrabble together as much money as possible and go into the market on their own, or they can hand their cash over to a professional manager who will do it for them.

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In all likelihood the latter option will see cash belonging to a number of small investors pooled together and invested as one large chunk in a collective investment fund.

Before prospective players get to the stage of deciding between the two, however, they need to make a decision on timing. Is now a moment for buying, selling or for avoiding altogether? This is, and always has been, an extremely difficult call to make, even for the experts. This year it has been harder than usual.

The Irish stock market has lost more than 30 per cent of its value in the year to date, with some unlucky stocks such as this year's biggest loser, Elan, seeing their losses extend above 90 per cent (see table). The picture is not an unusual one, with similar losses repeated around the world, regardless of country or stock exchange.

Mr Nigel Poynton is senior portfolio manager in the private client division of NCB Stockbrokers, a position which puts him in a better position than most to identify market trends. In recent weeks NCB's stance on equities has become reasonably bullish, meaning that the broker considers this a reasonably good time for investors to buy shares.

The optimism is limited, however, with NCB still branding the US market as something of a no-go zone. The flipside of this, according to Mr Poynton, is that European stocks are looking good, at least if the right shares are chosen.

"European markets relative to US equities are good value," says Mr Poynton, highlighting the sound dividend history of long-standing European companies operating in more traditional industries. He believes that the rewards are most likely to come for investors who are prepared to progressively enter the market over the next 18 months, and can then afford to hold their chosen stocks over a three-year horizon if necessary. He warns, however, that the average shareholder should still be prepared for a bit of a rocky ride, taking care not to expect a return to the heady days of the technology boom.

"I don't think the volatility has gone away," Mr Poynton says. "People have to show a cool head and a lot of patience. It's more a process of rebuilding confidence than anything else. People got very used to making 20 or 30 per cent gains in a short time whereas, pre-1990s, normal equity returns were low single digits or early teens when smoothed out over a 10-year period. People are now becoming a bit more realistic."

Mr Martin Nolan, chief investment officer with Hibernian Life and Pensions, agrees that European markets probably represent a buying opportunity, especially for investors willing to take a long-term view.

Both market-watchers say the economic conditions that traditionally underpin a sound stock market performance - low interest rates and low inflation - are currently in place, thus suggesting that the upturn will come, eventually.

When it comes to actually pursuing a buying strategy, the most straightforward approach is probably to enter the market on a personal basis, engaging a stockbroker and making your own investment decisions based on the information available.

Mr Poynton, whose clients tend to have several hundred thousand euro to spend on their equity portfolio, says that the smaller your investment sum is, the more diversification you should be seeking in the shares you buy.

This means that risk is spread over various companies and various industries, with the result that a crisis in one section of the market will not spill over to wreck an individual's entire personal worth.

This is a fine piece of advice, and one which an investor in any asset class should try to keep in mind when thinking of opening their chequebook.

There is one problem with the average person applying it to the stock market, however, in that expenditure in the €10,000 range does not offer much diversification elbow room.

Most Irish brokers apply a commission charge of about €50 before they will conduct a trade (buy or sell a share) for a client. This relatively hefty charge means that people of more simple means will have to think carefully before deciding to get into or out of a stock, a factor which immediately adds to the stress of owning shares in the first place.

Investors will have the option of spending less on their broker by using an online execution-only service, but this will not come with the back-up of research or one-to-one guidance that a full-service broker will provide.

Mr Poynton says that, with €10,000, the best policy would probably be to spend €2,500 on four individual stocks, spreading the risk across four industries. In the Irish market this could mean buying one bank, one pharmaceutical company, one construction-related firm and one other.

But even this will not be sufficient diversification to provide capital protection unless you turn out to be an expert stock-picker.

The alternative to picking your own stocks and shares and accepting all the risks involved is to pool your money together with other people in a collective investment fund. The most significant downside with collective products comes in the fee your fund management company will charge for its services.

Making matters worse is that the fee structure will often be confusing for the novice investor who does not feel comfortable wading through jargon. The best way to judge the value of your chosen collective product is, according to Mr Nolan, to compare it to the best return that would be available on the simple deposit account, since that is what you will be giving up when you enter a fund.

He recommends that smaller investors who simply cannot afford to lose their nest-egg should select a capital-guarantee fund allowing for "switches" or changes between asset classes. Most collective funds offer this facility, with some allowing a number of switches free.

"The way to go about it would be to put your €10,000 or €15,000 into a collective product, tell the fund manager that you want to put one-third into equities and two-thirds into cash. Then you can switch at a time of your choosing. It's an easy way of making sure that you don't get it wrong."

The advisory firm Financial Engineering Network (FEN) urges even more caution, having moved clients away from equities and equity-related products over the last six months and plumping for cash instead.

"We're saying to people, cash is king. The simple fact is that the markets, in our view, are too volatile to go into today," says Mr Paul Overy, of FEN, who likens investment in markets as they stand to "Russian roulette".

He acknowledges that his firm's fee-based status, whereby it does not accept commission from the companies whose products it sells, allows it to adopt a somewhat elitist stance. Unfortunately, for smaller investors, firms such as this tend to be out of reach, with only those with hundreds of thousands to invest really able to justify the fees involved.

He suggests that one area where investors could seek solace until the stock market woes have passed is tax breaks, with areas such as student accommodation or retirement homes offering significant benefits.