A beginner's guide to investing in the stock market
By Kate Saines
With savings rates on most UK accounts so low, taking a risk and putting your money into the markets is looking a more attractive option.
But if you've never dipped your toe into these waters before, the idea may seem overwhelming.
There's the risk – after all, shares can go up or down in value.
Then there's all that jargon – words like 'equity' or 'gilt' or 'market cap' may as well be in a foreign language.
And then there's the money – surely you have to have an absolute fortune to invest?
Well, investing really is not as daunting as it sounds. And you don't need to be a millionaire, either.
We've compiled a basic guide to give you an introduction to this mysterious world to help you decide if it's right for you.
What is the stock market?
Before you start to invest, it's important you know what you are investing in.
The stock market is a place where shares, also known as stocks, are bought and sold. It's a bit like your everyday food market, but instead of traders flogging fruit and veg they are selling shares in public limited companies.
A company's share price is only worth what people want to pay for it. So, if a company is doing well, the public will be keen to buy it and therefore they will pay a higher price.
If a company's having a bad time, the share price will be low because demand for it will also be low.
There are lots of stock markets across the world. Within the markets there are specific indices that list the various companies into which the public can buy.
In the UK we have the London Stock Exchange (LSE). The main index on the LSE is the FTSE100 and this contains the 100 companies with the highest market capitalisation in the UK.
'Market Capitalisation' is a great example of some investment jargon. It is referring to the number of shares a company has to sell and how much these are worth. If you multiply the number of shares by the price, you'll get the 'market cap', as it's also known.
It provides a way for the companies to value themselves, and as buyers we can usually spot an attractive company as it will have a high market cap.
There are plenty of other indices which contain different publicly listed companies. The smaller companies tend to trade on these more obscure indexes and the larger firms on the FTSE.
How can I invest in these markets?
There are a number of ways you can invest in a company. The first and most obvious is to buy individual shares in a company.
Shares, also known as stocks or equities, are available to buy in any companies listed in the London Stock Exchange.
The big blue chip companies in the FTSE100 will probably provide the less risky options as these firms tend to be bigger and more successful.
But you can find smaller companies with shares at lower prices - these have the potential to provide growth over the years, in other indices like the AIM or FTSE Small Cap.
You can choose to earn money through your shares by receiving a dividend or by selling them after a period of time.
A dividend is a regular – often yearly or six-monthly – payment made from the company's profit. People who want to earn a regular income from their shares choose this option.
Others wait until the share price has risen sufficiently and then sell the shares. This method is a bit of a gamble as prices go up and down all the time. But over the long term – ten or more years – shares tend to grow enough to make investors a pretty decent return.
You can also combine these two methods.
The disadvantage of investing in shares is that their value can go up or down. There's always going to be an element of risk attached.
Buying shares in just one company is obviously more risky than spreading your money out and buying shares in several.
And this leads us nicely on to another method of investing in the markets, which is through funds.
The main kinds of funds – and the ones you’re most likely to have heard of – are unit trusts and open ended investment companies (oeics).
Also known as collective investments or pooled investments, they are basically a collection of lots of different shares picked by fund managers, many of whom spend their days researching companies and picking stocks to create a successful fund.
Unlike investing in individual shares yourself, this method means someone else does all the work for you.
And the fact that these funds can invest in a variety of companies, means the risk is spread. You can spread your risk even further by investing in multi-manager funds, which are funds investing in lots of other funds.
There are many different types of funds. Essentially, the basic types are income funds, which invest in companies where dividend payments are attractive.
Then there are growth funds, which seek out companies who look set to grow and whose shares will eventually sell at a much higher price than they were bought.
And you can get balanced funds which mix the two. These tend to contain bonds, which are less risky, to help offset the risk.
On the downside, the fact you are getting someone else to do all the work for you comes at a price and you'll have to pay an annual management fee and an initial charge.
The way funds are priced is a little complex, the price of buying a unit in the fund will be calculated by the fund manager based on the value of all the assets divided by the number of shares available. And in some funds the price includes funds managers' costs.
Another way of investing in the markets is to buy bonds. A bond is essentially a loan – so when you buy a bond, you are giving the company money which it will eventually pay back with interest.
You can also buy gilts, which are government bonds. These are considered less risky than bonds because (we are told) the government is a highly reliable borrower and will not default on a loan. However, recent events in the Euro Zone, particularly in Greece, Ireland and Portugal have shown that government bonds are not as safe as they were.
Bonds are normally issued so a company can expand and it can often take between five to 15 years for a bond to reach its maturity.
Bonds usually pay interest twice a year, either at a fixed rate or a 'floating rate'. The term 'issuing a coupon' is used to refer to this interest being paid.
Although bonds are less risky, in general, than equities the risk factor varies from bond to bond.
They are all rated according to how likely the company is to pay back the loan. Like equities, you can also invest in bond funds.
Find out more: For more information on how to invest in UK companies take a look at a transcript of a webcast where experts answer questions on the subject here.
So, how do I get started?
To invest in individual shares you will need to go through a broker or a financial adviser. There are also companies set up specifically to help you invest – places like The Share Centre will give you access to all the investment options mentioned above.
Of course you can access funds by visiting the fund management companies directly. However, it's not a good idea to start investing until you have spoken to an expert.
There are so many shares and funds out there that it would be impossible to know which one suited you until you speak to someone who has a better idea of how they work.
A financial adviser or broker will be able to assess your attitude to risk, find out what you want from your investment (growth, income or both) and how much you have to invest.
Of course it's also essential that you make the most of your tax allowances. The first £10,680 will be ISA-able.
Use the Myfinances.co.uk comparison tools to find the best type of investment for you.
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