The stock markets are a popular place for investors to place their savings. Typically, in periods of low interest rates, those who invest in stocks and shares will yield more attractive returns than those with a savings account.
With the exponential growth of the internet, it is now easier than ever to trade stocks and shares online. Not only through stock brokers, but banks as well now offer online trading accounts, letting you buy and sell listed shares.
Our guide will show you how to invest in stocks and shares. Once completed, you’ll understand:
- What stocks and shares are?
- What you can invest in
- Typical fees when you invest in stocks and shares
- Dividends and the positive effects of compounding
- Tax efficient ways to invest in stocks and shares
- Why diversification is important
So, what are stocks and shares?
A stock is a share in the ownership of a company. Each share will represent a claim on the company’s assets and earnings. As you acquire more shares, your ownership stake in the company becomes greater.
Ownership of a company’s shares gives you the right to vote in shareholder meetings, receive dividends if and when they are distributed, and give you the right to sell your shares to somebody else.
Being a shareholder means that you are entitled to a portion of that company’s profits, which forms the cornerstone of a stock’s value. The more shares you own, the larger the portion of the profits you get.
However, there are a number of stocks that do not pay out dividends – some businesses prefer to reinvest their profits back into growing the company rather than paying it directly to their shareholders. These retained earnings will be reflected in the value of a stock where investors feel the business is using this re-investment of profits to grow the business successfully.
Now, the price of any given share will rise or fall according to the laws of supply and demand, driven by the perceived attractiveness of the company, its products and services and their subsequent performance.
A successful investor will pick stocks that other investors are likely to desire in the future.
How to invest in stocks and shares?
There are thousands of shares available to trade. Investors tend to prefer to buy and sell shares in their home country, but many now trade the big share markets like the US, UK, and Japan.
Increasingly we’re seeing the emergence of massive international companies with a global presence which, although they may be listed on a specific market, have operations – and exposure – around the world. Just because a company is listed in the UK does not mean it is a UK company.
Take a look at the FTSE 100, the benchmark UK stock index, and you will see many companies that are not even British. The choice of market by the listing company may be dictated by the company’s ability to raise money on that market – via an IPO (Initial Public Offering) – rather than the country in which it does business. Companies can be listed on multiple exchanges as a result.
Companies are often classified according to their size. Large cap, or ‘blue chip’ companies are considered to be the biggest and most secure, usually with a market capitalisation (the value of their total listed shares) in excess of $5 billion. Below these are the mid cap companies, worth between $2 billion and $5 billion. Below $2 billion and you’re in the world of small cap firms, the potential giants of tomorrow, potential acquisition targets, or tomorrow’s bankruptcy headline.
Small cap investing is a riskier business than buying blue chip shares, but the possible gains can also be larger. Small caps are also rarely tracked by analysts, which means the price is more likely to change suddenly on company news. We review small-Cap stocks where we feel they are well positioned for growth. You can find them here.
Invest in International stocks and shares
It is possible to trade foreign shares online as well, but this can be more expensive. In addition, you take on the additional currency risk – the change between your investing currency and the currency of the market you are trading. This can cut both ways, sometimes enhancing the value of your foreign shares, and sometimes eroding it.
How much does it cost to invest in stocks and shares?
Typically, investors will pay a fee for each transaction they make, whether that’s a purchase or a sale. Fee’s vary depending on your stockbroker and it’s important to consider how regularly you will trade shares, as each transaction will impact any profits you make from share price growth or dividends.
If you are planning to make regular trades, many brokers will offer active trader rates designed to help you increase your profits. However, you will need to make a minimum number of trades in order to qualify for these attractive rates.
Stockbrokers may also charge annual fees to offset their administrative fees. Look out for these annual charges and make sure you understand the likely cost of depositing your money with your chosen stockbroker. You’ll find that some stockbrokers will limit the amount of annual fees their clients pay – a position that will help you to keep track of your costs.
Dividends and the positive effects of compounding
As we have now established, investing in stocks and shares effectively give you a stake in that business. By owning shares in well-managed businesses, you are aligning your wealth with their success which means you’ll be entitled to a share of any profits in that business that are distributed as dividends.
You can take these dividends as cash, effectively providing you with an income which you can spend as you wish. Bear in mind that these dividend payments may be subject to tax implications depending on your own financial situation.
If you don’t need those dividends today, you can use them to buy more shares, meaning you’ll earn more dividends in the future. This is called re-investment of dividends and is essential for investors wishing to grow their wealth through the powerful effect of compounding.
Invest in stocks and shares tax efficiently
For the smart investor, there are a number of tax efficient ways to invest in stocks and shares. In the UK, investors can place a lump sum each year in a Stocks and Shares ISA (Individual Savings Account) that is tax free and exempt from any Capital Gains Tax, meaning that any profits you make from investments within a Stocks and Shares ISA are sheltered from the tax man.
In the 2017/2018 tax year, investors can place up to £20,000 each into their Stocks and Shares ISA.
It is also possible for parents or guardians to place up to £4,128 per child per tax year into a Junior Stocks and Shares ISA while adults between the ages of 18 and 40 can place up to an additional £4,000 each year into a Lifetime ISA, designed by the government to encourage younger generations to start saving for their first home by offering them an extremely attractive 25% yearly bonus.
Retirement investing for beginners
Stocks and Shares can also be held in a Self Invested Personal Pension or SIPP, that offers UK Investors a tax free way to save for their retirement. The government limits contributions to £40,000 per annum or £1 million over a lifetime but as a general rule, investors can place any amount up to their full annual salary into this type of scheme.
As part of these contributions, the government will add the tax relief amount to an investors yearly contributions making them an extremely attractive way to invest for retirement.
So, why is diversification important?
When considering any investing for beginners strategy, it’s important to understand that stocks and shares can go down in value, as well as up.
Now, companies will react individually to a variety of economic factors. Inflation, recession, the increase or decrease in value of the pound or rising interest rates are just a handful of factors that can have a broad range of effects on UK investors.
Investing all of your available funds in a single company, or a number of companies with a similar set of products or services in the same sector – such as finance for example – will increase the risk to your portfolio. It only takes the economy to turn against you for your investments to, potentially, lose considerable value.
Choosing a number of companies with different characteristics will reduce an investment portfolio’s exposure to specific events. While it is inevitable that some stocks will lose value as certain times, this will not be the case for all stocks within a fully diversified portfolio.
For this reason, it is important that investors choose a broad spread of companies. We would suggest measuring your investment ideas against the criteria below to ensure your portfolio is appropriately diversified.
- Have you chosen stocks and shares across a range of sectors? (eg, retail, finance, healthcare, technology, manufacturing, support services). If not, consider including stocks that will spread your exposure.
- Do your investments derive revenue from a single country or region? If so, consider including stocks and shares that generate revenue from other regions around the world.
- Do you have any defensive stocks and shares? (eg, companies that provide products or services that are necessary even when the economy is weak). If not, consider utility companies, food manufacturers or retailers such as supermarkets.
- Do you have any stocks that are likely to perform very well in periods of global growth? If not, consider luxury goods such as technology stocks, fashion retailers or travel and leisure businesses.
- Is your portfolio heavily weighted towards one company stock or sector? If so, consider reducing your exposure to maintain a more even balance across all of your investment.
- Does your portfolio include large cap stocks (less growth but generally offer bigger dividends and low volatility) and small cap stocks (more growth but greater volatility)? If not, consider a balance that aligns with your attitude to risk.
Find out if you should invest in stocks and shares
Check out our risk profiling tool and find out if you should invest in stocks and shares. It takes seconds to complete and will help you to understand which products are suitable for you, based on your appetite for risk.
We hope you found this guide useful. If it has given you the confidence you needed to invest in stocks and shares and begin your journey as a self-directed investor, let us know. We’d like to hear how you are getting on.
We’d be grateful if you would share our guide with your friends too. Help us to spread the word that investing in the stock markets is an effective way to grow your wealth.