What are shares?
A share represents a small slice of ownership in a company. Companies sell shares, or equity, to raise money to fund their business and fuel their growth. In return, the buyer receives a stake in the business and the opportunity to profit from its success.
There are two main types of shares:
- Ordinary shares, the most common type, offer the right to vote on company matters and an equal portion of any earnings distributed.
- Preference shares, also known as preferred shares, don’t carry voting rights but do provide first dibs on dividends and a greater chance of getting paid in the event of bankruptcy.
How do shares work?
A company will first issue shares often with an initial public offering (IPO). Once this fundraising process is complete, these same units of ownership can be bought and sold through an electronic marketplace called a stock exchange.
Each country has at least one market where buyers and sellers can trade shares. Companies registered within its borders will be assigned a unique short letter code, known as a ticker, for identification purposes, and then split into different subsections or indices based on their size or industry they operate in and other attributes.
Investors mainly make money from shares in two ways:
1. Capital growth
Sell shares at a higher price than you bought them for, and you will pocket a capital gain or profit. Share prices are determined by how investors view the company’s future prospects. When everything is rosy, more people will probably buy the shares, and their price will rise. By contrast, when the outlook is bleak, demand will fall and so will their value.
2. Dividends
Prosperous companies sometimes reward shareholders with a portion of their profits, either regularly or on a one-off basis. A set sum per share will be allocated, meaning that if a company paid out a dividend of £3.37, it would net an investor holding 10 shares in the company £33.70.
Dividends are fairly common among big, stable companies. Smaller firms, aggressively chasing growth, likely will reinvest their profits into the business.
Pros and cons of investing in shares
Pros
Buying shares gives you the opportunity to hitch your fortunes to some of the world’s most successful companies. It’s also a good way to grow your money and avoid it getting eroded by inflation, as it may in the average savings account.
Over the past 120 years, global equities produced an annualised return above inflation of 5.2%, according to Credit Suisse, comfortably outperforming all other major categories of investments. That’s the entire market, though. Individually, some shares fared much better, others considerably worse.
Cons
Picking the winners isn’t easy. Without a crystal ball, it’s hard to say whether a company that looks unstoppable now will remain that way for decades to come. It’s generally advisable not to wager your stake in just one company, but rather diversify your investments across different types of companies and industries.
Investing in shares comes with risk and you could end up with considerably less than you originally invested if it goes wrong. It’s vital you fully understand the market before you make any financial commitment.
How to buy and sell shares
You’ll need a brokerage account to trade shares on a stock exchange. There are plenty of online platforms to choose from, and selecting which is best for you will depend on your individual requirements. In many cases, the most cost-effective option will be one that charges the least to buy and sell shares. Prices tend to come down the more regularly you trade, and a frequent trader may prefer a different platform than one favoured by novice or buy-and-hold investors.
Once you’ve settled on one, don’t forget to make use of your annual tax-free ISA allowance and set up a nominee account that gives the broker permission to hold shares on your behalf and take care of all the paperwork.
Platforms are fairly straightforward. Many offer access to research on companies, so that you can be an informed investor. When you’re ready to buy, search for the company you want to invest in and specify how many shares you want.
From the moment the order is executed, you can keep tabs on your investment, buy more or sell. Be sure to check you’re happy with the quoted price before proceeding with transactions – valuations can fluctuate a lot during the business hours that the stock market is open.
» MORE: What you should know about investment platforms
How much should I invest in shares?
How much you should invest will depend on your circumstances — what you are saving for, how long you have to achieve your goals and whether you can afford to do without your money during that time.
Remember, there’s no set minimum for shares. You can begin with a small lump sum, and then steadily add a little to your account each month.
How to choose which shares to buy?
Start by considering how much you’re willing to risk to achieve your investment goals.
Identifying the next Amazon before anyone else could make you a fortune. Just remember that however optimistic or aspirational a company might seem, many will encounter hurdles along the way and fail to live up to their promise.
You will have to decide in the company profile that you feel most comfortable with. For example a big stable company that pays a dividend and has survived and prospered during decades of industry-wide change.
After identifying the sort of companies you’re comfortable entrusting with your money, examine their annual reports and financial statements (accessible on investegate.co.uk) to establish if they’re in sound health. It is also vital that you understand exactly what they do and how they operate, then have a good think about what the future could hold, whether their ambitions are feasible and reflected in the share price.
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in
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