Shares – the engine of growth
November 2009
The search for growth, as you might expect, leads to investing in the stock market.
Shares rise and fall on a daily basis, but over the long term, history has shown they have the potential for much higher returns than savings accounts or government bonds – as long as you are prepared to accept the risks.
It is important that when you invest in shares you look at the longer term. Investing in the short or medium term carries more risk, but if you are prepared to hold your shares for over 10 years, for example, provided you have a wide range of shares, then the risk of ending up with less than you originally invested reduces.
Recently the stock market has been extremely volatile seeing substantial falls in share prices. If the markets fall over a sustained period you could lose a lot, if not all of the money you invested..
What are stocks and shares?
Essentially, a share is a small stake in a public company. When you buy a share, you are buying a part of a company, therefore becoming a joint owner in that company along with the other shareholders. Normally shares, sometimes called equities, refer to shares listed on the stock exchange.
The term “stock” refers to shares of a company, so there’s no real distinction between stocks and shares. To hold some of a company’s stock is to have shares in that company. Shares in various companies are traded on stock exchanges around the world.
When a company issues shares for the first time - an Initial Public Offering (IPO) - it usually does so in order to attract growth or investment capital. These shares are then bought and sold on the exchange.
The value of shares in a given company will tend to vary over time, typically depending on how well the company is performing in terms of profits and growth. In general, the better a company is doing, the more investors will be willing to buy shares in that company.
You can make money from shares in two ways. First, you can sell your shares at a higher price than you paid for them (known as a capital gain). There is, of course, the chance that the value of your shares (the share price) can also fall, which is where the element of risk comes in. The second way of making money is through share dividends (an income). If a company makes a profit, it will sometimes distribute these profits among its shareholders however, in the recent financial crisis, some companies have not paid a dividend so there is another risk that dividend income can fall or not even be paid at all.
How do you invest in the stock market?
These days there are lots of ways you can invest in the stock markets. Shares are no longer just for the rich few. Most banks offer a share dealing service and many stock broking services offer share trading online.
Then you have a more complex series of choices to make: which companies to invest in, across which sectors, in which markets.
So, one way or another, you do have to be confident that you know what you are doing before you even contemplate buying direct. And at some point all share deals are made through a stockbroker - a professional market trader registered with the Financial Services Authority (FSA).
Stockbrokers can now be contacted directly in a number of ways, with the internet becoming increasingly popular. This means that, if you have the money, you can tell a stockbroker exactly how to invest it on your behalf.
Alternatively, the stockbroker can provide advice on how and where to invest your money, and which shares to buy, or you can simply leave it up to them to make all of your buying and selling decisions for you. Remember, they will charge a commission on any transactions you make so you need to keep an eye on these costs.
The alternative to going directly to a stockbroker is to invest in shares through a unit trust or investment trust. A unit trust is a type of pooled investment trust – ie you pay in money along with other investors, which is invested in the stock market, through stockbrokers, on your behalf.
Your investment in the trust is measured in units - hence the name. These are good if you want flexibility in your stock investments, but without the responsibility that may come with direct investing.
Equally though, you lose some control over your investments as the trust managers will make the decisions about which shares to buy. You get some control in deciding which trust or trusts to invest in. Some may specialise in emerging markets while others will perhaps focus on smaller companies. You can choose units for growth and for income. The choice is huge and it’s worth taking advice that the funds you choose meet your needs.
Investment trusts work in much the same way as unit trusts. The main difference is that investment trusts are companies that make their money through investing in other companies.
If you want to read more about investment, dip into our feature Investment made simple.
