Why you too can invest successfully with shares

What image do you spontaneously have in your mind when you hear something about shareholders or owners of a company? Older gentlemen with suit and chauffeur? Surely there are those too. But it has never been as easy as it is today to become a shareholder yourself. And it can be worthwhile, especially in times of low interest rates on savings.

Around one in six Germans invests in shares. This can be done with just a few euros and an online securities account. Especially in the past few months, many new investors have joined the ranks. In this guide, you will learn some basics: how stocks work, how you can best use them for your long-term investment, and how you can reduce the - undoubtedly existing - risk.

1. What are shares?

Shares are an old form of investment that works in a surprisingly simple way: A company issues securities that embody a piece of the company itself. In other words: Whoever owns the shares calls the shots in the company. This is particularly true of the so-called major shareholders, who own a double-digit percentage share or even the majority of a stock corporation. However, companies like Apple, Daimler or Siemens also have many small shareholders. When business is good, they also benefit - through an increase in the value of their shares and sometimes through a payout or distribution of part of the profits (dividend).

While you can only become an investor in a non-listed company with negotiating skills (and are usually rebuffed), you can do this on the stock exchange with just a few clicks of the mouse. It provides a uniform framework for shares to be sold from one person to another. The stock exchange is therefore nothing more than a marketplace.

Now the price of a share comes into play. After all, a company doesn't keep issuing new shares. The existing shareholders would not like that, because additional shares would reduce their share in the company. A so-called capital increase can only take place by majority resolution. This means that if the number of shares remains the same and the company becomes more valuable as a result of its business success, the value of the individual share also increases. They can then be sold later at a higher price.

2. Why you need shares

A balanced investment consists of different asset classes. It should be clear that your money does not increase in a checking account. You can't expect enormous returns with overnight money and time deposits either.

But if you split the savings amount, new opportunities arise. The compound interest effect helps here. Over the past decades, a broadly diversified stock portfolio has grown much more strongly in value than a savings account. Despite all the crises, stocks have proven to be a high-yield investment over the long term. Compared with safe government bonds and short-term interest investments, they have generated the highest returns, as studies have shown. Over the past 44 years, an index fund that tracks the performance of the MSCI World index has generated an average annual return of around 6.7 percent on a euro basis. The MSCI World index includes more than 1,600 companies from 23 countries. Financial market researchers have even calculated back to 1900 and come to similar conclusions.

The following chart also shows that share prices have risen over the long term in the past. It shows the net performance of the MSCI World in US dollars. Net means that withholding taxes, which are due in some countries on the dividends of the shares included, are deducted. The chart thus shows how the value of the MSCI World shares has developed in percentage terms since 1970. In the long term, the trend has been steeply upward. At the end of April 2022, the share price stands at over 8000 percent.

But it is also unwise to take an overly naive view of stocks. Stock market prices fluctuate, sometimes wildly, and you have no guarantee that you will be able to achieve a certain sum with your shares on a specific date. The opportunities also entail a risk - but you can limit it. That's why the interaction between your bank balance and your stock portfolio is so important, as is your specific stock strategy, as we explain below.

In this way, you reduce the risk not only by investing for the long term. It is just as important that you put your money broadly spread in many shares. Experts talk about reducing the company risk. Here's an example: In August 2018, a U.S. court ordered the company Monsanto to pay a large amount of damages. Monsanto had concealed the cancer risk of a crop protection product containing the active ingredient glyphosate. On the day of the verdict, shares in the chemical company Bayer, to which Monsanto belongs, lost 14 percent of their value. Since the ruling only affects Bayer and not other companies, it is referred to as corporate risk. For example, if you only owned Bayer stock at the time, the 14 percent hit you hard. If, on the other hand, Bayer shares were only one of many stocks in your portfolio, the loss only affected you minimally. It may even have been offset by price increases in other companies.

How to buy shares

To invest broadly in stocks, you do not have to buy a large number of individual stocks. Instead, you can put your money in a fund that then invests in many individual stocks for you. We recommend index funds, so-called ETFs. You can easily buy shares in these funds with a securities account, for example on the stock exchange.

Buying securities via your online securities account is in itself not much more complicated than a transfer at your bank - but you will certainly have many questions about it, especially the first time. Here on this page we clarify the theory behind the shares. The practical part is explained in our guides Buying Shares and Creating a Savings Plan.

3. Why do shares rise in the long term?

The big question, of course, is why the value of shares should continue to grow so steadily in the future. After all, stock market trends are uncertain. No one knows where the world stock market will be in a few years, for example. You can deduce a certain pattern for the future from past returns, to be sure. But there are still forecasts that may or may not come true.

Here, however, a theoretical view can help. A company's purpose is to make a profit. That is, it wants to earn more money from the sale of a product or service than it cost to produce it. Of course, this sometimes works better, sometimes worse and sometimes not at all. But if you look at a large group of companies over a longer period of time, they should on average make a profit. And: It is to be expected that the owners, in this case the shareholders, will get more out of it in the long run than if they put their money into the bank account instead of shares. Because that's what they would do otherwise, of course - why bother with the whole business otherwise?

One concept for this is the "hierarchy of the capital market." Savers deposit money with banks. Banks lend it on at a higher price (interest) so that they themselves make a profit. Large borrowers, in turn, are companies. They also aim to make a profit - and as a result want to provide their shareholders with a higher return than the loans they took out to make it worthwhile.

This representation is also known as the "chicken ladder on the capital market". As a shareholder, you climb to the top of the chicken ladder, so to speak. Borrowers and savers are below you. They get the crap of the chickens above them.

When the economy grows, corporate profits also rise. Profits, in turn, are the long-term fuel for rising share prices. You don't have to be an expert to recognize that a company becomes more valuable as its earnings rise each year. This correlation is also confirmed by research. Studies show that share prices follow earnings over the long term. Accordingly, investors can continue to have legitimate hope that share prices will rise as long as the global economy continues to grow. (By the way, economic growth does not automatically have to do with high resource consumption - even a recycling company or a media group can be very profitable and grow).

Where does the high return on shares come from?

4 ...and why do share prices fluctuate strongly in the short term?

However, in the short and medium term, i.e. between one month and a few years, share prices do not necessarily move in step with corporate earnings. It is possible for stock prices to rise faster than earnings over a period of years, and vice versa. In the late 1990s, for example, stock prices shot through the roof while corporate profits grew much more slowly. This led to extreme overvaluation on international stock exchanges, as a result of which prices collapsed. Such examples show that in the short to medium term, profit trends can be overshadowed by other factors that determine investors' buying and selling behavior. The most important factors are:

Interest rate development - The greatest influence in the short term is exerted by central banks, which influence interest rate levels through their monetary policies. Falling interest rates often lead to higher share prices. There are several reasons for this: The current value of future expected profits increases. This makes shares more attractive. Shares also appear more lucrative compared with fixed-interest investments such as time deposits and bonds when interest rates fall. For companies, financing costs fall and investments become more profitable. This in turn fuels hopes of higher profits. Rising interest rates tend to have the opposite effect.

Economic data and sentiment indicators - Countless economic data are sent around the world every day. Some of these reports move share prices. These include figures on labor market trends, corporate investment behavior, inflation in Germany, and customers' propensity to buy. After all, private consumption makes a significant contribution to economic performance.

Herd behavior - There are always fashions on the stock markets that can strongly influence prices for a short time. At the end of the 1990s, for example, enthusiasm for Internet and other technology companies culminated in euphoria. However, such trends are ultimately only interim episodes, as stock market history shows.

Risk appetite - When dark clouds gather in the markets, as in 2020 at the beginning of the Corona pandemic or in 2008 during the financial crisis, many investors get scared. They flee from risky to safe investments. Stocks are sold. This pushes prices down. If, on the other hand, there is a lack of concern on the stock markets, more and more investors jump on the bandwagon - and share prices continue to shoot up. Investor sentiment can fluctuate wildly.

Politics - Governments set the economic framework. New laws and regulations can have a positive or negative impact on the entire stock market or on individual sectors. One example is the liberalization of financial markets. This benefited international banks, whose stock market value increased disproportionately compared to the overall market. However, because of the financial crisis, politicians turned the wheel back again. In the meantime, the banking industry is complaining that regulation is too restrictive. As a result, the share prices of many institutions significantly underperformed the market as a whole.

Structural change and (mis)success - Some business ideas are perennial favorites, others eventually lose their luster. Technological progress gives rise to streaming providers and analog film producers fade away. If a company adapts to changing market conditions, it can be successful and also increase its stock market value with a changed product range. In the worst case, however, a company goes bankrupt, through incompetence or even fraud - see Wirecard. The shares then become worthless. With a broad diversification, such as a global equity fund, you can minimize this (rare) risk for yourself.

5. What is the impact of news on the stock market?

For newcomers to the stock market, it is often confusing at the beginning how new economic data is interpreted on the stock market. For example, one company reports record profits and its share price falls. Another company reports losses, and investors pounce on its shares. This seems absurd, but it is not. Because on the stock exchange, the future is traded. It's all about expectations. The present and the past are of little interest.

Investors buy a company's shares because they think it will make higher profits in the future. If the company then actually increases earnings to the extent expected, this will have little impact on the share price. If earnings are good but lower than hoped, some investors turn away disappointed - the share price falls. If, on the other hand, the Group exceeds expectations, this can lead to further increases in the share price. What applies to individual companies also applies to macroeconomic data, such as unemployment figures. If they turn out better than expected, this is good for share prices and vice versa. The stock market is constantly full of such surprises.

Because people love stories, they tend to justify the sober event ("price rises / falls") with a narrative. This fills the stock market reports, but often remains an assumption, because it is not queried during a stock purchase and sale why an investor has decided in such a way. News can also be interpreted in different ways. While higher growth is basically positive for the stock market, it can under certain circumstances lead to central banks raising interest rates. And that, in turn, can depress prices. The bottom line is that it depends on which effect is given the greater weight on the markets. The stock market is sometimes a game of several rails. As a beginner, you should always remember this when you think you no longer understand the stock market world.

As a long-term oriented investor, you can follow the daily ups and downs in a relaxed manner anyway. Temporarily falling prices and a bad mood that lasts a few months are, in retrospect, no more than a footnote in the price history. As a stock investor, you should always keep this in mind if you get nervous about falling prices and start thinking about getting out. Theoretically, of course, interim losses can be limited by selling. The problem is: when do you get back in? Most investors wait until the prices have already risen significantly again. But the bottom line is that you lose money. As a long-term investor, it is therefore smarter to ride out price slumps - even if the fear of a loss hurts.

6. What is the role of dividends and the Annual General Meeting?

When you buy a share, you become a shareholder and thus a co-owner of a stock corporation (AG). According to your share, you participate in its profits and losses. If the AG goes bankrupt, you do not have to put up more money or pay for the debts, but your share will probably become worthless. On the other hand, the owners share in the profits of a corporation. A part of it is distributed to the shareholders. This payment is called a dividend. Stocks are therefore also called dividend stocks. Shareholders vote on the amount of the dividend at the annual general meeting. Even if there was a profit, the meeting can decide not to pay a dividend and to keep all the money in the company.

Small shareholders, who only have a stake of a hundred or a thousand euros in a corporation like Deutsche Telekom, have no measurable influence on management decisions. However, the Board of Management, which runs an AG, cannot do everything that suits it either. It is monitored by the Supervisory Board, whose members are in turn elected in part by the shareholders. In addition, AGs in Germany and most other countries must regularly inform their shareholders about business developments. Some AGs issue two types of shares, preferred shares and common shares. Holders of preferred shares usually receive a higher dividend, but only investors with common shares then have voting rights at the Annual General Meeting. Volkswagen and Metro are well-known examples of this model.

As a shareholder, you are invited to the Annual General Meeting. Some depository providers charge a fee when you order an admission ticket, so check the price list.

In 2020 and 2021, virtually all AGMs were held not in large event halls, as is usually the case, but by video transmission because of the Corona pandemic. It is true that it is more convenient and less expensive for small shareholders to follow the shareholders' meeting from their sofa at home. But investor representatives such as the Deutsche Schutzvereinigung für Wertpapierbesitz criticize the fact that virtual meetings often do not allow spontaneous questions to be put to management.

If you are not an individual shareholder, but a fund saver or ETF investor, as Finanztip recommends because of the better risk distribution, you also benefit from the dividends. They are either paid out to you regularly (in the case of distributing funds) or invested in additional shares (in the case of reinvesting funds). However, you are not allowed to participate in the annual general meeting. The fund company can do that on your behalf. Large ETF brands such as Blackrock or Lyxor regularly publish reports on where and how their representatives voted.

7. What is a stock index?

By far not every company is a stock corporation, and not even every AG is listed on the stock exchange (Deutsche Bahn AG is a well-known example). But the shares of 1,000 companies are traded on Germany's largest trading venue, Xetra, alone. Categories make things clearer: a distinction is made, for example, between large, medium-sized and small companies. The companies with the highest market capitalization are called blue chips or large caps. In Germany, the 40 largest blue chips are listed on the German Stock Index (Dax).

A stock index expresses the performance of the companies listed in it in a single number. In this way, you can see at a glance how an entire market is developing on average. Indices are calculated according to fixed formulas and their value is measured in index points. Instead of points, the term numerator is also often used. In simple terms, an index rises when the prices of a majority of the companies listed in it rise. The index falls when the prices of the companies predominantly fall.

Gains and losses are usually expressed as a percentage in the media and on financial websites on the Internet. On Tagesschau.de and Finanzen.net, for example, you can follow how the world's most important stock indices are developing. However, many other websites as well as daily newspapers and specialized media also offer such market data.

Stock market experts call medium-sized companies mid-caps. In Germany, they are listed on the MDax. The SDax groups together smaller companies called small caps. Mid- and small-caps are also known as second-line stocks.

Similar indices to the Dax family are calculated for almost every country where there is a developed stock market. The main index, which combines the largest blue chips, is usually referred to as the leading index. Market observers consider it representative of a country's market because it captures a large portion of the total market capitalization. In Germany, the Dax is the leading index.

International stock indices

In the U.S., the S&P 500 is considered the leading index, tracking the 500 largest companies based on market capitalization. S&P stands for Standard & Poor's, one of the most important index providers worldwide. A much respected traditional index for the American market is the Dow Jones, which, however, is not considered representative by experts. In Japan there is the Nikkei, in Great Britain the FTSE 100 and in France the CAC 40.

The MSCI World Index is virtually a global benchmark index. It contains almost 1600 blue chips and mid caps from 23 countries. In each of these countries, the world stock index covers 85 percent of the market capitalization. However, the countries included are exclusively economies whose stock market landscape is classified as "developed" by the index provider. Countries such as China and India, which are considered emerging markets, are not included, and South Korea has also been left out so far. They are subsumed separately by another index, MSCI Emerging Markets. The combination of developed and emerging markets is called MSCI All Countries or ACWI. With the FTSE All-World Index, the British index provider FTSE offers an alternative.

However, indices are not only calculated for countries and regions. There are also sector and strategy indices, for example. Sustainable indices, in which some companies are deliberately not included, are becoming increasingly popular. There are hardly any limits to differentiation. The index provider MSCI alone calculates 150,000 indices every day.

The composition of stock indices is reviewed regularly. For example, if a company from the MDax outperforms a Dax group in terms of market capitalization, it can be promoted to the leading index. Another value is relegated in return - as in the German soccer league. And this has similar consequences: Fund managers who follow the index performance dump the stock. This can depress the share price significantly. Up-and-comers, on the other hand, are bought, which has a positive effect on their share price.

Indices are calculated in different ways. There are so-called price and performance indices. The former only reflect the price gains of the companies they contain. The latter also include dividends. When calculating them, it is assumed that the profit distributions are reinvested in the shares of the respective companies. The Dax, for example, is a performance index.

However, only a fraction of the more than 11,000 AGs are listed on the stock exchange in Germany. According to the World Federation of Exchanges (WFE), only the shares of just under 440 domestic companies were listed in this country in 2021. Their stock market value, or market capitalization, totaled a good 2.1 trillion dollars. Measured by this, Germany is the eighth largest stock market in the world. However, the market capitalization is equivalent to only about 50 percent of the local economic output per year. Seen in this light, the market in Germany is underdeveloped.

In the USA, by far the world's largest stock market, the value of listed companies is almost twice the economic output. These figures reflect clear cultural differences: While owning shares is taken for granted in the United States, Germans exercise restraint.

8. Higher returns = higher risks

The annual return on a share is made up of price gains or losses and any dividend paid. Not all companies distribute part of their profits. Some retain them entirely to finance their further growth. In the case of the 40 (by 2021: 30) largest listed German companies in the Dax index, dividends have accounted for half of their performance on average in recent decades. The dividend yield, i.e. the annual payout in relation to the current value of a share, averaged 3 percent for the companies listed in the MSCI World over the past decades.

However, the comparatively high returns that could be achieved with shares in the past were also offset by high risks. This is one of the few irrefutable laws of the financial markets: Wherever there are high returns, there are always correspondingly high risks of loss. Nothing is given for free on the capital markets.

Conversely, a lower return, as in the case of overnight money and fixed-term deposits, is the price to be paid for the great security of these investments. In contrast, shares can fluctuate wildly. Interim losses of more than 10 percent are not uncommon - especially after a long period of rising prices. Much more severe crashes are rarer, but must still be taken into account.

For example, the MSCI World stock index lost more than half its value on a euro basis between 2000 and 2003. That was the worst crash in the past four decades. At that time, the technology bubble on the international stock exchanges had burst. It took more than 13 years to recover this loss from the perspective of a German investor. Share prices also plummeted between 2008 and 2009, at the height of the financial crisis. In the meantime, investors had to absorb losses of 49 percent. In this case, however, the recovery was much more rapid. After just under six years, the losses had been recouped. The recovery was even faster in 2020 after the first Corona wave, when the setback of over 30 percent was made up in less than a year.

How do you spread the risk?

The risk that share prices will fall on average worldwide or in just one region is called market risk. In addition, there is the so-called corporate risk. This refers, for example, to management errors that put pressure on a group's profit performance. Bankruptcies also count as corporate risks.

However, investors can easily eliminate such risks by investing not only in individual companies, but in a large number of companies from different sectors and countries. If one company is not doing so well, this is offset by others where business and share prices are currently developing better. This tactic is called diversification or risk spreading.

Diversification, the most important basic rule

Unlike corporate risk, market risk cannot be eliminated in the short term. Investors can only dampen it by spreading their money over other, and above all safe, investments besides stocks, such as overnight money and fixed-term deposits. Bonds as well as bond and real estate funds also come into question. In the long term, however, the market risk of a well-diversified stock portfolio is not that high. It decreases with increasing investment duration. For example, anyone who invested in the 30 Dax companies for 13 years (since 2021 there have been 40) has not suffered a loss in the past five decades - completely irrespective of when they entered the market. This is shown by the yield triangle of the Deutsches Aktieninstitut.

It shows the average annual returns of the Dax for any given investment period. It is worth taking a closer look at this chart, especially for newcomers to the stock market. It gives you a good sense of the role that time plays in investing in stocks. For example, it can be seen that the entry and exit times also become less and less important as the investment period increases.

With an investment horizon of 15 years, average annual returns still depend heavily on the entry point. In the best case, 15.4 percent per year could be achieved over the past 50 years (end of 1985 to end of 1999). In the worst case, the annual return was only 2.3 percent (end of 1999 to end of 2014). The difference is around 13 percentage points. This gap shrinks as the holding period of the Dax portfolio increases. After 30 years, only 4 percentage points separate the best and worst entry points.

Even a portfolio invested almost exclusively in the MSCI World index would have always achieved a positive annual return after 15 years over the past 40 years. This is what we calculated in our investment guide.

Why are we telling you all this? Because the second elementary principle of investing in stocks is derived from such data:

Only invest what you will not need for at least 10 to 15 years.

It is best if you do not need the money for a longer period of time. The more time you can give yourself, the lower the risk of having to sell in a crisis. If you take this to heart and, with the help of the yield triangle, keep in mind that time is running out for you on the stock market, then you can sit back and relax if the stock markets once again temporarily go to their knees.

10. Invest with small amounts in stock funds

Many ways lead to the stock market: You could, for example, put together your own stock portfolio. This is inexpensive, because you do not have to pay anything for the management. With a cheap broker, the purchase fees are also very low. For most investors, however, this is too time-consuming. Research and selection of suitable stocks cost a lot of time. It is much more convenient to invest in equity funds.

Basically, you have the choice between two types of funds: One is managed by a manager who buys and sells shares according to a specific strategy. The others have no manager. They simply copy stock indices, such as the MSCI World Index. These funds are called index funds. Because most of them are traded on the stock exchange like stocks, they are also called exchange-traded funds, or ETFs for short. With these funds, you always perform almost exactly like the respective index - minus the management costs, which are quite low for most index funds.

This is one of the reasons why Finanztip recommends index funds. With them, you can save several thousand euros in management costs over the years compared to a fund with a manager. In addition, only very few managers succeed in outperforming the respective market average over the long term. This is another reason why it makes sense to invest in an index fund. For beginners we recommend ETF on the MSCI World. You can find a selection in our ETF Finder.

If you do not have any capital yet, you can invest with a savings plan. This is possible with some banks for as little as 25 euros per month. A savings plan on an MSCI World ETF is a very good building block for long-term asset accumulation. You can read about how savings plans work and where you can get the best conditions depending on the respective savings rate in our savings plan guide to index funds.