How to invest in shares
After a patchy start to 2014, stocks are on the up again with investors collectively piling millions into the market. Following hot on the heels of the US S&P 500 index reaching its best ever level, the FTSE 100 index of the UK's top firms went on to hit a 14-year high in September.
The number of Brits looking to build and manage their own portfolio of individual stocks is rising rapidly - just look at the dash for Royal Mail shares a year ago.
It's easy to see why shares remain attractive. When you invest in the shares of a company, you become a part owner in that firm, giving you the opportunity to profit from the firm's potential future success. But dabbling in shares can be an intimidating and risky business.
Doing your homework, knowing your goals and forming good trading habits are all key. So for intrepid investors looking to take the DIY route - rather than invest in funds that select shares and spread the risk - we explain what you need to know to get started.
The primary reason people invest in shares is that, over the long term, even though they can be volatile, they tend to beat what you can earn from a savings account. Stockmarket investors are usually looking to boost their income or grow their capital or achieve a combination of both.
Investors looking to generate an income opt for generous dividend-paying firms (companies that share their profits with their investors), while those wanting to enjoy capital growth tend to look out for fast-growing companies to generate their returns.
For many investors, having a balanced approach and combining growth and income stocks is the best route.
Dividends are usually paid twice a year and multi- nationals well known for their payouts include Vodafone, BP and Imperial Tobacco. Banks have also traditionally been a haven for income-seekers.
However, you do not have to bank the cash and can always opt to reinvest it instead, which can potentially be very rewarding, as you then benefit from compounding. For example, according to the Barclays Equity Gilt Study, which analyses long-term investment returns, £100 invested in equities at the end of 1899 would now be worth, in real terms, £191. But if dividends had been reinvested over the period, the value of the sum would be massively higher at £28,386.
But beware dividend traps, where firms in financial trouble offer large payouts in the hope of attracting investors – but a high-paying dividend is not much use if the company's shares end up collapsing. If you buy a share for its income potential, check the company has a strong track record of increasing its dividend year- on-year. Remember, dividends can be cut or removed altogether if a firm decides it needs to hang on to the cash.
Growth stocks are characterised by corporations looking to expand by acquiring other businesses, moving into overseas markets or have new technologies or products in development. But if you are looking to invest in growth-style shares, do your groundwork and look at how viable the potential growth is – how likely is an acquisition going to happen?
If a company is expanding, how much of an impact will it have? Bear in mind that if a company becomes a takeover target there may be a short-term hike in shares, which is often inevitably followed by a drop.
How to pick stocks
The movement of any share, whether up or down, is dependent on investor demand. If a company is doing well and/or is expected to grow its profits, its stock will rise in line with demand. Shares fall in value when investors sell out. When the market is doing well, shares from all sectors generally tend to rise and vice versa during rocky periods.
Experts often advise new investors to stick to what they know. Keith Bowman, equity analyst at Hargreaves Lansdown, says: "Investors should avoid investing in the shares of companies that they do not understand. Instead, look at businesses you are familiar with."
It is vital you do your homework but there is no shortage of tools at the disposal of investors. If you are thinking of investing in a particular firm, look at the firm's latest market update and annual report, check out what firms say about its prospects – all of which
are available online. Many websites – including Digital Look and Interactive Investor – provide a wealth of information and numerous online brokers also offer free weekly share tip emails.
When managing your portfolio, leave emotion aside – just because a stock was a good investment six months ago does not mean it still is now. Do not be afraid to cut your losses because even stocks that have already fallen sharply can always drop further. Graham Spooner, investment research analyst at The Share Centre, says: "If a company in which you are invested comes out with a bad set of results, or disaster has hit it in some way, don't look for the positive – the fundamental reasons why you are invested are no longer there anymore."
While investing in the stockmarket can be financially very rewarding, it comes with a not insignificant amount of risk – you could lose some, if not all of your invested cash – so never put in more than you can afford to lose. The key to success is striking a balance between risk and return.
Investing should be a long-term project and, as such, it is vital you take on a level of risk that will let you sleep comfortably at night. The general rule of thumb is that the higher the potential return, the greater the risk. FTSE 100-listed stocks such as HSBC and Marks & Spencer are sometimes referred to as 'blue chips'. These typically tend to move up and down far less than faster-growing, riskier firm's shares, which could potentially produce superior returns.
The easiest way to reduce your exposure to risk is by not having all your eggs in one basket: so spread your money over a number of companies and industries. For newcomers, a good place to start is to build a portfolio of relatively low-risk investments and then top it up with bigger-bet stocks. This way, you will find your feet and comfort zone a lot faster.
Many online brokers offer access to 'virtual' trading accounts where you can practise at trading shares free of charge and this can be a great way to get an initial feel for investing.
'Re-balancing' your portfolio
When you start investing, ideally you will build a diversified portfolio of stocks in tune with your risk appetite. But over the course of time, your investments will move up and down and 12 months down the line, your portfolio could look very different from its initial outlay.
For example, if you had invested 10% of your portfolio in mining stocks and another 10% in financials, while the former sector could have had a storming year, the latter may have been static. As such, you will have a lot more money invested in mining stocks now than you originally planned. As a result, it is wise to either bank some of the profits or reinvest into other parts of your portfolio, in order to get the asset allocation back to a comfortable balance.
One way to keep a good check on your portfolio is to set price targets that you can use to set a price at which you want to sell. Shares never move up or down in a straight line, so having price goals and discipline is vital in keeping your portfolio in line.
Where can you trade?
Buying and selling shares has never been easier and investors typically do it through an online service - of which there is a myriad to choose from, including The Share Centre, Hargreaves Lansdown and Interactive Investor. They offer investors plenty of tools and guides.
By trading online, it means you can view your portfolio 24/7, and there are plenty of apps which allow you to trade on the go. You can still trade over the phone but the costs will be higher.
What does it cost?
With an internet broker, costs average around £10 per UK trade, rising to around £15 to £20 for overseas markets. It is advisable to steer clear of brokers that charge a percentage, as this only tends to benefit very frequent traders with larger portfolios. Some brokers also have 'inactivity charges' if you do not trade frequently enough.
The best deals for straightforward trading are SVS Securities at £5.75 and x-o.co.uk at £5.95 per trade. Club Finance charges an annual 0.24% fee plus £2.50 per deal up to £250,000, £1 per deal up to £500,000, then 50p per deal above. Trading also brings with it a 0.5% stamp-duty charge.
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.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
All limited liability companies registered in the UK are compelled by law to compile a report once a year on the company’s accounts and directors’ statements must be issued to shareholders and filed at Companies House. A report details a company’s activities throughout the preceding year and its contents will include chairman’s statement, auditor’s report and detailed financial information such as cash flow and balance sheet statements.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).