Updated 03 September 2020
Should you invest in the stock market? It depends what you want to achieve. Some investors aim for long-term growth to beat inflation and the low interest rates on cash savings; others try their luck at making quick wins. Both are possible, but each requires a very different approach, significant risks, and often some hard work.
Here’s an introduction to investing in equities.
The stock market is a platform where companies sell small stakes in their businesses. Companies issue shares to raise capital that they can use to develop their business and make a bigger profit. You (the shareholder) hope to make a profit by judging supply and demand and buying shares when the price is low, then selling them when the price is higher.
That’s not the only way to make money on the stock market. Some shares pay you extra income in the form of dividends, which are a share of a company’s profits. You can opt to take the money as cash, or for dividend reinvestment, where the income is used to buy you more shares in the company.
There is also more than one way to become a shareholder. You can buy individual stocks and manage the portfolio yourself (or through a professional). Or you can buy Exchange Traded Funds (ETFs), which are a selection of investments traded on the stock market by a fund manager.
Your aim is to buy shares that are going to become even more popular and valuable, and to sell them when the price is the highest. Lots of factors affect the value of shares, including:
Apart from inflation, all of these factors have one underlying aspect in common: confidence. Supply and demand is all about how much confidence shareholders and those looking to buy shares have in the future of the companies and the market.
Stock price volatility means the value of your shares goes up and down. If yours go down by a long way, you may lose your money. But that is not to say stock market investment isn’t worth it – you will need to take a level of investment risk if you want to be in with a chance of making a decent profit.
The key is following a strategy that aligns with your goals and tolerance for risk. For example, if you’re nearing retirement, you may not want to put your savings at a high amount of risk. On the other hand, if you plan on working another 20 years and you have considerable savings, you may be more willing to take a risk because you have other money to fall back on.
An IFA can help you decide the best strategy. You need to weigh up whether to choose lower risk investments, such as ETFs, or if you want to try and make a quick profit through an individual stock day trade. Usually it’s about finding a balance with different types of investments (known as diversification), for example by including international investments and a range of asset classes too.
You can never be sure what you’re going to make from the stock market. People have made millions (Warren Buffet has made billions), while others have ruined themselves. The golden rule is never to invest more than you can afford to lose.
There are lots of graphs that show the historical returns of the stock market. You’ll notice a general upward trend, but one that is spiky with slumps and uplifts. This illustrates how a long-term investment is the best way to generate a return on the stock market. If you want to make short-term gains, you’ll have to buy in the slumps and wait for the peaks – this can be hard to judge, easy to get wrong, and very hard on the nerves. There are people who do manage it, but they work long hours doing their research.
The value of individual stocks will directly depend on how the company itself is faring. Again, knowledge of a company is crucial if you’re going to invest largely in one business rather than diversify across broader funds. Even massive corporations have been known to collapse.
With investing, you’re putting your money at risk, so you need to decide how much you can reasonably afford to lose should share prices fall dramatically. An IFA can help you calculate this amount. It will depend on all sorts of aspects, like your incomings and outgoings, plans for the future, who’s depending on your income and your risk tolerance.
Setting a monthly or yearly budget is a sensible way of staying on track with your investment strategy, to make sure you’re not risking too much. You may also like to think about the types of companies you’d like to invest in, especially if you want to invest ethically.
When you choose your financial adviser (see above), pick one who specialises in wealth management, as they will have the necessary investment expertise. IFAs are generally not stock-pickers, but they can usually help you choose the most suitable funds for your risk profile.
You should also do your own homework to get more out of your conversations with your IFA. Understanding the stock market and the shares you hold will help you make confident decisions about your investments.
Diversification spreads the risk in your portfolio. It involves investing in a range of shares, assets, fund types and sometimes alternative investments, so that if one company or fund takes a turn for the worst, others can absorb some of the loss. Some asset classes have what is known as an inverse correlation, which means that one tends to rise when the other is falling (commodities and equities can behave in this way, as can equities and bonds).
There are some costs involved with investing, because managing your portfolio takes time and skill – some of which you may have to hire from other people. Here are some of the common fees and charges you may come across:
The ongoing costs of looking after your portfolio can rack up and make a dent in any gains you may make. You’ll need to keep track of these fees and consider changing your investments if they begin to outweigh the benefits of your shareholding.
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