Investing in stocks - what are the options?
Have you decided to invest in stocks, maybe after one of our workshops, but you are wondering what are the options? In this article, we quickly review what options you have.
Buying stocks directly
You will purchase individual stocks of selected companies. The advantage is that you can specifically choose which stock to buy and when. The disadvantage is that if the particular company is not doing well at the moment, you may experience a relatively sharp decline in the stock's value. For example, the popular automaker Tesla reached its peak at around $400 in November 2021, and as of the date of writing this article, two years after that peak, it is trading at half that value, around $200. At the same time, you may also encounter the problem that $200 is a relatively high investment for you, and you would prefer to invest smaller amounts (this can be solved with brokers who offer the option to purchase fractional shares, as discussed below).
In general, this option is suitable for those who are willing to spend some time selecting stocks and monitoring the market. If you plan to hold the stocks for the long term, you might not mind that individual stocks may experience higher fluctuations in value. However, you are taking the risk that the companies may not perform well in the long run and may never regain the value at which you initially purchased them, while with the index, this is highly unlikely.
Buying and index (often referred to as ETF)
When you buy an index, you are purchasing the largest (in terms of total market capitalization) companies in a specific market. Global indices are available in two variants - whether they include emerging markets or not. These indices typically comprise between 1,500 to 3,500 individual stocks from around the world, depending on the specific index you choose. In addition to global indices, you can also buy regional indices, such as those for Europe, North America, Asia, and so on. Another option is to invest in national indices, with the most well-known being the S&P 500, a fund comprising 500 U.S. companies. There are also sector-specific indices and more.
The generally recommended approach is to invest in global indices because they encompass more companies, thereby spreading the risk more widely compared to investing in individual countries or regions. It is also significantly simpler, as you have just one product to manage. Whether to include emerging economies in your portfolio is a matter on which experts often disagree, but even in the broadest global indices, these economies typically represent only around 10% of the entire portfolio, making it a less critical decision.
Buying a mutual fund
A mutual fund is the third alternative, perhaps the most commonly recommended by banks, investment brokers, or financial advisors. Mutual funds have specific objectives and often aim to outperform a designated index. Because mutual funds are actively managed, the fund manager can, for example, anticipate that a particular company will not recover from a decline and sell it in time, whereas an index would continue to hold it blindly as long as it meets the index's criteria. This can further "secure" your investment to prevent significant downturns, which may be a priority for some investors. Additionally, there are significantly more mutual funds available than index funds, providing a much wider selection.
There are 2 downsides:
1. mutual funds charge management fees for the active management they receive. For stock funds, this fee is approximately 1.5% per year, which may partly explain why 80% of actively managed mutual funds perform worse than the benchmark index they are compared to.
2. with a mutual fund, you cannot choose when exactly to make a purchase. You send your money to investment company and it usually takes at least 1 week for them to invest the money in the market, which might miss you a nice buying opportunity.
Taxes (valid for Czech Republic tax residents)
According to the current tax regulations, it doesn't matter how you own stocks - if you hold them for at least 3 years, you are exempt from paying capital gains tax when selling them. For dividends (if the stocks pay them), you always pay a 15% tax on the dividend amount. For Czech stocks, the tax is automatically withheld, and you don't need to take any action. If you have foreign stocks with dividends, it is ideal if the country has a double taxation treaty with the Czech Republic. You can find a list of such countries here. If there is no treaty, you will have to pay an additional 15% tax, even if the dividend was already taxed in the country where the company is based. If there is a treaty, you will file a tax return and only pay the tax up to 15% (if the state has a lower tax rate), or you won't have to pay anything (if the state has a tax rate higher than 15%).
Safety and liquidity
The purchase is made through a broker in such a way that the broker does not own your money or stocks; they are held in your name (unlike, for example, cryptocurrency exchanges, which are not as regulated). If the broker were to go bankrupt, you would only have to wait until an alternative solution is found to grant you access to your assets (often, your portfolio is simply transferred to a new broker). Whether you own the stock directly or through an index, you will have the same level of accessibility - you can sell the stock immediately through the broker and have the proceeds deposited into your account, which the broker typically does within a few days. For mutual funds, you typically have access to your money a bit later, but we are still talking about a timeframe of 1 week to 14 days.
How to buy stocks?
You can purchase stocks directly through a broker. In the Czech Republic, you can try Fio Bank, which offers minimal fees when buying Czech stocks. However, if you want to buy foreign stocks, you will incur higher fees and currency conversion costs. You can try an international broker where you don't pay fees for purchases and send the currency in which the stocks are traded directly to the platform to avoid currency conversion fees. For instance, we have tried and tested XTB, a broker with whom we also have an affiliate partnership - you can use this link to support our activities: Broker XTB. If you register through our link and gradually invest an amount of 10,000 CZK (or equivalent in a different currency), we receive a reward of 600 CZK, thank you.
We have a separate article on investing in indexes, which you can find here: Investing in stock index
Mutual funds are very accessible and can be arranged practically anywhere. Sometimes your bank may even encourage you to invest through them by offering a higher interest rate on a time deposit. You can also arrange them through a financial advisor or directly with a representative of an investment company.
Disclaimer: The information in the article is for informational purposes only and is not investment advice or a recommendation. All information such as tax rates and conditions is accurate as of the publishing of the article.