Stocks and Shares: why they could be a big win for you

May 28, 2015

The stock market is a very interesting place indeed. In fact, it’s so interesting most people avoid it all together. Hopefully, over the next few articles, we’ll be able to help you understand a little more about what investing in the stock market actually is, and how you can begin to actually invest in it.

Ignore the hype

Turn on one of the financial TV channels and you’re bombarded with a whole host of complicated information. Tickers at the bottom show you lots of green and red digits that aren’t easy to understand, analysts talk about particular companies or stocks that are on the up, and there’s a sensationalism and urgency about the whole thing that makes it seem more like a night at a casino.

But, with a little understanding, we can strip away the showmanship and find out exactly what investing in the stock market is. So, let’s start with something simple. If we keep in mind that all sorts of things are traded on the stock market, then we can think of investing in it as buying a little piece of one of those things. Hopefully, over time, the thing will grow in value, enabling you to buy more little pieces, or take the money as income.

Sound simple enough? Then let’s move on to take a look at the most common thing you can buy when you decide to invest in the stock market: stocks.

What are stocks and shares?

The first thing to clear up about stocks and shares is that you might know them as something different, namely equities or securities. It’s relatively straightforward to clear up why – when you buy a stock, you’re purchasing a little bit of the company, which means you now have equity in it. It’s the same with securities – you secure a share of ownership in the company. Don’t worry about the names, they all mean the same thing.

As an individual, you’re allowed to buy a share in any company that is traded on the stock market. Let’s say you decide to buy a share in Apple. Congratulations! You now have a share of the company’s ownership. Broadly, that means that if Apple does well, you will be rewarded for having a share of a successful business. If the business doesn’t do very well, you might find the value of your share going down.

So, why would you buy shares in the first place? Well, some people will buy them and sell them very quickly, while others like to buy shares and hold them for a long time. We’ve already covered what it means to invest, where we talked about putting money into financial schemes with the expectation of achieving a profit. By buying a stock, you have the potential to make money from either the price of the stock going up and you selling it when it’s worth more, or through dividends.

Let’s say that you invest in a toy company that makes those monkeys that wear a waistcoat and play the cymbals. You know the ones? Well, you buy a share in the company for £1, and then BOOM! Monkeys-with-cymbals toys become the next craze to sweep the Western world, and every child has one on their Christmas list. Suddenly, the company is doing really well, making money, and the stock that you own in that company becomes highly attractive, pushing the price of the stock up to £5. The success means more investors will be interested in owning that stock and riding the monkeys-with-cymbals wave. You can think of it like any supply and demand equation – the greater the demand for the company’s stock, the more expensive the stock becomes to buy. And as the owner of a share in the company, you benefit. The price of the stock going up is called price appreciation. When you sell that stock, you’ll make a profit because it’s worth more than it was when you bought it – perhaps enough to buy your own monkey-with-cymbals.

The other way to earn money is through a dividend, which is where a company shares its profit with you. The more shares that you own, the more dividend you’ll get. Some people might choose to do this for the regular source of income, although don’t forget that the income is still based on the company actually making a profit! If no-one’s buying the monkeys anymore, don’t expect a big cheque in the post.

There could be advantages to owning specific stocks…

A simple way of entering the stock market is to pick a stock in a well-known and successful company, hold it for many years, and hopefully see some long-term value. And that value increases even more if your stocks pay dividends – if you reinvest those dividends, you will end up owning more and more of the company, meaning more dividends, and more profit.

Sounds amazing, right? But, what if the company goes bust? What if you buy shares in a tech company that is superseded by a new major player (like when Apple upset the, um, apple cart, by launching their original iPhone)? What if the entire stock market slumps because of a totally unexpected event? Not so simple and amazing any more.

And there are more downsides…

For the average beginner taking their first steps into investing, buying and selling stocks is nice and straightforward. Does that mean you should do it? Well, consider this: every single trade you make has a fee. Buying some stock? The broker gets a commission. Selling a stock? Commission. These commissions soon add up, so if you’re an impulsive trader who is trying to buy and sell depending on when you think the company’s stock will rise or fall, then you might find yourself in a jam.

One thing you mustn’t forget is that you aren’t just going into a shop and buying a loaf of bread for a fixed price. You’re buying a loaf of bread where the price is constantly changing depending on a multitude of factors, where computers are buying and selling that bread in micro-seconds using complex models, where teams of researchers working for hedge funds are working out the exact time to buy the bread, and where mathematicians are relying on complex algorithms that they’ve designed to produce the highest possible returns. If it sounds intimidating, then good. You’re right to be cautious. The stock market can be a wonderful place for many investors, but it can also hurt beginners.

Remember, the value of investments can fall as well as rise. You may not get back what you invest.

So are stocks for you?

Who knows? Only you can answer that question (but remember that we’re here to help!). At the beginning of this article, we said that there are lots of different ways to invest in the stock market and we’ll be covering more in the coming weeks.

Until then, think of this as your stocks and shares diving board – we’ve explained the board itself, but there’s still a lot to learn and understand about the pool…and the water is deep. That said, just like you’re not going to learn to swim from a book, you’re not going to learn about investing until you start to invest – however small your first steps.

 

This article is for general use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be or constitute advice.

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