Mind the share trading gap and keep an eye on size, says MR MONEY MAKER Justin Urquhart Stewart

The key issue 

I am afraid to say that my industry has built up a poor reputation not just for bad communication and service with its clients, but also for a less than spotless record when it comes to costs and charges.

Investment costs, while not being always straightforward, should be clear and simple. Sadly, the investment market has built up a lexicon of terminology which is not always understood even by its professional practitioners (I must admit that I have been guilty in the past of making up some terminology just to see if ‘experts’ could be fooled – and they were). 

There is even one well-known firm that produces a separate booklet on all their direct charges for clients! 

Don’t get caught out: A spread is the difference between the sale and purchase price on any stock or fund

What is it? 

There is one issue, though, that I wanted to bring to your attention as you build up your portfolio expertise, and that is ‘spreads’. Simply put, a spread is the difference between the sale and purchase price on any stock or fund. 

For most investors, they would only see one price quoted in the paper, but in fact there is often quite a considerable gap between the two prices. 

Now, for very well-known companies in which there is a lot of trading, the difference can be quite small and just a few pence. 

However, for smaller companies the spread can be very wide, as trading volumes are infrequent. The size of these spreads can be as much as 5 per cent, which means your investment has to grow by at least that before you are in profit. 

Sometimes the spread can be more than the price of the share itself.

Then note liquidity 

When we buy shares we always like to think that we can easily sell them again. These are ‘liquid’ stocks, which just means there are plenty of them, so it’s not a problem to buy or sell. 

However, if you go outside say the FTSE 350 (the top 350 by market capitalisation) the liquidity, or tradeability, in that stock diminishes rapidly. Some may be untradeable at that moment as there may be either no buyers or sellers. 

So what you bought now becomes a burden until a buyer turns up. 

The smaller the company, the less liquidity there is, so diving into the smaller companies on, say, the AIM (Alternative Investment Market) can become a one-way street unless you are careful. 

There are ways in which this can be managed by, for example, trading in that small company once a year. 

That means the trades can be concentrated to create liquidity for a brief period before it evaporates and your oasis of trading disappears into the sand again.

Your rule? 

Never buy a share or stock before checking how tradeable it is, and how wide that spread really extends. 

Your share price may technically double, but unless you can sell it, then that profit is just an illusion.  

Justin Urquhart Stewart co-founded fund manager 7IM and is chairman of investment platform Regionally. 

This post first appeared on Dailymail.co.uk