A beginner's guide to investing in the stock market
In the UK, the main stock market is the London Stock Exchange, where public limited companies and other financial instruments such as government bonds and derivatives can be bought and sold.
The stock market is split into different indices - the most famous in the UK being the FTSE 100, comprised of the largest 100 companies. The most well-known indices come from the Footsie group - the FTSE 100, the FTSE 250, the FTSE Fledgling and the alternative investment market (AIM), which lists small and venture capital-backed companies.
Unlike cash, the stock market is not a risk-free investment; it has its ups and downs. For more information, read our article What is the stock market?
In the 20 years between December 1996 and December 2016, you would have enjoyed returns of 65.3%.
The ten years between December 2006 and 2016, meanwhile, would have seen returns of 13.6%, and the five years between December 2011 and December 2016 would see you repeating returns of 26.9%
There are two ways to access the stock market: directly, and indirectly. Although 'directly' is a misnomer - investing in the stock market is always done through a third-party broker - direct investment means buying the shares in a single company, and becoming a shareholder.
There is a wide range of broker services available. Some offer bespoke services and tailored advice, such as Charles Stanley, Redmayne Bentley and Killik & Co, whereas others are nothing more than execution-only share dealing services.
These are online platforms through which a client can buy and sell shares independently through a share dealing account, without being offered advice.
Examples of these include Interactive Investor, Hargreaves Lansdown or The Share Centre. Read Moneywise's guide to the best investment platforms for beginners.
"For beginners who want to be more involved and dabble with individual shares, it makes sense to open an online, execution-only share dealing account which keeps the cost of investing to a minimum," says Martin Bamford, managing director of Surrey-based IFA Informed Choice.
Reading the financial press can be useful in terms of choosing which shares to buy, Mr Bamford adds. "There are also plenty of internet forums where share tips can be found. Don't part with your money to receive share tips, as there is plenty of useful information in the public domain free of charge.
"Stick to companies you find interesting and spend the time researching a company before you invest."
Moneywise's sister website Money Observer is a good place to start, as it lists the full performance, along with yield and price/earnings ratio, of shares listed on the major FTSE indices each month; as well as performance for funds, trusts and exchange traded funds - more on those later.
An indirect approach through investing in pooled investment funds is a more common way of accessing shares, as it spreads risk by investing in a number of companies.
"Beginners are best suited to using collective investment funds to access the stock market," says Mr Bamford. "This enables them to use the collective buying power of a fund to reduce charges on a small starting portfolio. They also get access to a professional fund manager to buy and sell individual stocks, rather than having to make these decisions on their own."
This can be done via an open-ended fund, such as an open-ended investment company (OEIC) or unit trust, which is made up of shares typically from between 50 and 100 companies, and can be sector, country or theme specific.
Money in these funds is ring-fenced away from the fund provider, so if the firm defaults, the money is still safe.
An investment trust is another pooled investment, but it is structured in the same way as a limited company. Investors buy shares in the closed-end company, and it is listed on an index in the same way as a company such as Tesco or RBS. Trusts are less numerous than funds, but often cheaper.
Many investment funds and the majority of trusts are actively managed products, run by a fund manager who handpicks stocks and has some direction over the performance of the fund. In contrast, some funds invest passively, which means they just try to replicate the performance of a major stock market index. These are called tracker funds.
An exchange traded fund (ETF) is another type of passive product. ETFs are vehicles that simply track an index such as the FTSE 250. As index-linked products, they can access almost every area of the market.
ETFs are far cheaper than funds or trusts, as there is no active manager to pay for. However, as they simply track an index, if the index falls spectacularly, so will your investment.
All the investment vehicles described above can be accessed through a broker or fund platform, directly through the asset manager or through a tax efficient wrapper such as a stocks and shares individual savings account (Isa).
As for more complicated investments, Mr Bamford has some words of advice for beginners: "Leave spreadbetting and day trading to the professionals, as these can be high-risk ways of investing money."
He adds: "When you are getting started, it makes real sense to buy blue-chip company shares on the London Stock Exchange and hold them for several months. Regular trading will kill profits quickly, with the cost of buying and selling shares exceeding the returns you can make from a small starting stake."
A fund-of-funds or a multi-manager fund, which is a single fund investing in a range of others, can be a good starting point for novices as it demands little involvement from the investor.
"It's proactively managed and investors can choose a risk profile which suits them, so they are secure in the knowledge that the investments are in line with their expectations," says Peter Chadborn, founder of Colchester-based IFA Plan Money.
However, these types of funds are more expensive than investment trusts and funds.
What to be aware of
There are several things that investors should be aware of before committing any money to the stock market.
"As a starting point, you need to decide what you want to achieve, how long you are planning to invest for and how much risk you are prepared to take," says Patrick Connolly, certified financial planner at AWD Chase de Vere, "as this will help you decide which investments are appropriate".
Tales of other people's huge gains can be tempting, but the market won't always go in your favour and you must be prepared to see your investment drop as well as fall. "You must understand your tolerance to risk rather than appetite for reward. Risk and reward go hand-in-hand, and any investor must consider the potential downsides before investing," says Mr Chadborn.
"Secondly, investors must understand the structure of the investment: look at the fund factsheet rather than the glossy marketing material," he comments. "The factsheet will tell it warts and all, rather than what the company wants you to see."
The costs involved in buying funds, trusts, shares or ETFs can vary massively, and higher fees can easily eat away at future returns. To ensure value for money, Mr Chadborn highlights the importance of comparing charges on different products. "By buying directly from a fund supermarket, you'll benefit from reduced initial charges on funds, as compared to a big retail outlet like a bank."
That said, fund supermarkets, also called investment platforms, don't offer advice, so for a novice investor, it may be better to seek some professional, independent advice from a financial adviser before making any investment decisions.
Without the help of a crystal ball, timing the market is impossible. Instead, look to invest regular premiums on a monthly basis rather than a depositing a lump sum into a fund. By drip-feeding money in, it's possible to negate the risk of market timing - if the market falls, the regular premium will simply buy shares at a cheaper price the following month.
"Don't get swayed by investments just because they are at the top of the performance tables," warns Mr Connolly. "Strong recent performance should be seen as a warning sign, as the investment gains have already been made, rather than as an opportunity to buy." For more on this read The emotional diary of the (not so) smart investor.
The final key point is that investments should be held for at least five years to smooth out any bumps in the market, but that doesn't mean once they're bought they can be left unchecked.
Mr Connolly concurs: "Review investments every six months to ensure they are performing in line with expectations. If they aren't, try and understand why and then look to make changes if appropriate."
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This article first appeared on our sister website, Money Observer.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
An Exchange traded fund is a security that tracks an index or commodity but is traded in the same way as a share on an exchange. ETFs allow investors the convenience of purchasing a broad basket of securities in a single transaction, essentially offering the convenience of a stock with the diversification offered by a pooled fund, such as a unit trust. Investors buying an ETF are basically investing in the performance of an underlying bundle of securities, usually those representing a particular index or sector. They have no front or back-end fees but, because they trade as shares, each ETF purchase will be charged a brokerage commission.
Describes the relationship between a client and a stockbroker or independent financial adviser whereby the broker or adviser acts solely on the client’s instructions and doesn’t offer any advice on which shares to invest in or financial products to buy and simply “executes” the wishes of the client, regardless if they are judged to be sound or wrong. Other types of broking service offered are advisory (whereby the client/investor makes the final decisions, but the broker offers advice) and discretionary (whereby the broker manages the portfolio entirely and makes all the decisions on behalf of the client).
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Alternative Investment Market
AIM is the London Stock Exchange’s international market for smaller companies. Since its launch in 1995, 2,200 companies have raised almost £24 billion listing on AIM. The market has a more flexible regulatory system than the main market and can offer tax advantages to investors but its constituents are a riskier investment than bigger companies listed on the main market.