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How to invest in shares
Investing in shares is a way to generate income, save for the future and speculate on individual companies, sectors and the entire stock market. Of course, the value of your investments can go down as well as up. In this short 7-step guide we will explain the basics of investing.
What is an investment?
Investing is a way to put money to work – in other words instead of parking excess cash you have in the bank and getting a fractional amount of interest, an investment is expected – but not guaranteed – to deliver a higher return. Investing is inherently riskier than leaving money in the bank. There are lots of ways to invest – from property to fine art – but arguably the most common and simplest way to invest is in the stock market.
How do stock markets work?
Stock markets are simply a marketplace for shares of individual companies. Buyers and sellers meet to exchange shares. In the past this was all done in person on trading floors, but increasingly the vast majority of buying and selling shares is carried out online via a network of regulated exchanges like the NYSE, Nasdaq and London Stock Exchange among others.
Companies issue shares – each one a claim on a tiny portion of the business – in order to raise cash to grow, or sometimes for founders to exit the company. The process of listing shares on an exchange is usually called an Initial Public Offering, or IPO. Usually individual investors can only purchase shares once the stock has begun trading.
Sometimes companies already trading on the stock market will issue fresh shares to raise more money, which can reduce the price of the shares already on the market. Sometimes they carry out buybacks, when the company buys up existing shares to reduce the number of shares, which can increase the price of the remaining shares.
At all times, shares trading on public exchanges are constantly changing hands as private investors, sovereign wealth funds, hedge funds, pension funds, mutual funds and private equity firms buy and sell stocks based on the most up-to-date information they possess. This creates a market and gives us a share price, which is usually quoted as the mid–point between the bid price – the highest price a buyer will pay – and ask price – the lowest a seller will accept.
What is a share?
A share is simply a right of ownership of a fraction of the company. It entitles the owner to a financial claim on the business and usually entails voting rights which are exercised from time to time, for example if a company is subject to a takeover. For example, there are about 70bn shares of Lloyds. If a large shareholder owned 7bn shares, they would own 10% of Lloyds and would have considerable sway over the company.
How much income can investing generate?
The first thing to bear in mind is that investing is not a one-way street – the value of your investment can go down as well as up.
But the idea of investing is to grow the value of your assets over time. There are two ways you can generate returns. The first is capital appreciation – the value of the shares rising over time to be worth more than they cost you. The other is through dividends, which is when a company returns some cash to shareholders from the profits they make.
Dividends are like interest payments on a savings account, only they can be more volatile since these depend on each company deciding to pay a dividend. For example, in 2020 the coronavirus pandemic saw large numbers of companies suspend dividends in order to protect their balance sheets. Nevertheless, the FTSE 100 was able to offer investors a dividend yield of around 4%, which is considerably more than the 0.1% Bank of England base rate.
How can I invest in shares?
The simplest way to invest in shares is to open a share dealing account. It’s a relatively straightforward process and within minutes you could be building your very own stock portfolio.
You can pick individual shares or choose to invest in a broader collection of shares that give you exposure to different areas of the economy.
Example: UK stocks
For example, you may like to invest UK banks, so you could split your portfolio across Barclays, NatWest, HSBC, Lloyds and Standard Chartered. Or you could decide you would like exposure to the UK property market, because for instance you think house prices will rise and the market is fundamentally sound. In this case, you may only invest in Lloyds and NatWest but also purchase shares in housebuilders like Barratt Developments and Persimmon, as well as estate agents like Foxtons and Countrywide.
How do I decide which stocks to buy?
There are thousands of stocks to invest in, so choosing which shares to buy can seem daunting. There are lots of different approaches to investing, from value investing to growth investing. Growth stocks are companies with the potential to outperform the broader stock market because they are expected to grow earnings at a much faster rate than other stocks. Value stocks are considered those trading below what they are ‘worth’.