Risk and reward

1  2  3  4  5  6  7  8  9   

5. Specific risk

There are actually two kinds of risk to stock market investing. The first is called Specific risk, also known as "alpha risk", and it is the risk that comes with holding shares in individual companies. Companies can go through bad times, and if they do their share price will drop.

The conventional wisdom is that you lessen specific risk by investing in a range of companies in different sectors. If you own 20 different stocks in at least 10 different sectors, the chances of them all doing badly are much reduced.

Example

Some people argue that it's better to put all your eggs in a smaller basket (say 10 shares) and then watch that basket extremely carefully. There is some logic to this, as it can be difficult to monitor 20 different stocks, but for most people a spread of 20 is safer.

If the amount you have to invest is under £10,000, investing in 20 companies will result in a rather thin spread, and the commission costs will be high as a proportion of your capital.

There are four ways you can mitigate this:

1. Invest in fewer companies
2. Invest in a unit trust

   You buy units in the trust, it pools your money with everybody else's and invests it in quoted companies. It charges a management fee, then distributes its dividend income to unit holders. If its investments do well, the value of the units rises.

   Good points: you get a spread of investments and the putative benefit of professional management.

   
   Bad points: the bid-offer spread on units can be wide, and management charges can be high.
3. Invest in an investment trust

   Similar to unit trusts except ITs are themselves quoted companies and you don't buy units but actual shares in the IT.

   Good points: you get a spread of investments and the putative benefit of professional management. Charges are low compared to unit trusts. Can work well with savings schemes.

   
   Bad points: IT shares frequently trade at a discount to the value of their underlying assets, and their shares can be volatile.
4. Join an investment Club

   An investment club is an association of private investors who pool their money and invest it together. There are rules about how these are set up and run, but they have two big advantages. Firstly, they are a sociable way to learn about the stock market; secondly there are no management charges to pay.

1. The right place for your spare money? 2. The golden rule 3. Stock market performance and inflation 4. Stock market performance compared to savings accounts 5. Specific risk 6. Market risk 7. Pound cost averaging - a way round risk 8. Overseas investments - currency risks 9. Conclusion

• Against the Gods