Trading in shares can be a way of making your money work harder for you. By investing in shares, equities or funds you could generate a better return on your money than if you held it in cash.Buying stocks and shares can also give your money some protection against inflation. However, investment carries some risk because when you buy shares the value can go up and down and you may not get back what you paid for.
What is an investment?
An investment is an asset that you buy that isn't cash. It might be property, bonds, shares or other financial products. An investment in the stockmarket is when you buy shares or funds in the hope that they will increase in value while you own them. An investment is a long term prospect and you should not use money you will need in a hurry.
What is a share?
A share is simply part ownership of a company. Also known as equities, shares represent a share of ownership in a company. You own a small portion of a company and potentially share in its growth and profits.
Shares are listed on a stock exchange where they are bought and sold by investors. When you invest in shares (ie find a share to buy), you're buying a small stake in a company. You become a joint-owner of the company along with all the other shareholders. You benefit from any growth in the value of the company, but you also take a hit if the company’s profits fall because the value of the shares you own may fall too.
Why should I buy shares?
When looking to buy shares, the aim is for the shares to grow in value over time. Shareholders may also to benefit from a share in the profits of the company in the form of a regular payment, known as a dividend.
Shares give investors the opportunity for a steady income and capital growth, although neither of these is guaranteed. Some people buy shares for growth, others for the regular dividends. Some shares provide both growth and dividends. Neither is guaranteed.
Some investors buy shares in order to receive a regular dividend income. You can do this either by holding a number of different companies that pay dividends, or by buying a share in a fund, which aims to pay a regular income to its investors.
Why should I invest in stocks and shares rather than cash?
Historically, over the longer term, which is considered to be at least ten years, shares have generally been a better performing asset than many other forms of investment, such as cash and bonds.
In addition, any underlying growth in the value of the shares you own, known as the capital growth, will protect you against the effects of inflation. This is the rise in the cost of living which affects the real buying power of your money. By keeping all of your money in cash in the bank your wealth will be affected by inflation gradually reducing its real value. This is one of the main reasons that people look to invest in stocks and shares in the stockmarket.
However, financial experts will always point out that past performance is not necessarily an indicator of how well an asset will perform in the future. You should aim to hold shares for the medium term because their value can rise and fall.
What are the risks with buying stocks and shares?
Share prices can fluctuate suddenly, and sometimes very sharply, and this is why shares are considered a higher-risk investment than cash, bonds and property. It's also the reason why they are more suitable as a longer-term investment - if you invest over a longer period you're in a better position to ride out any fluctuations in the market.
Not all share investments carry an equal risk, the level of risk depends on the company you are looking to buy shares in.
A small start-up with an innovative product will have a higher risk profile than a larger company, for instance, but the attraction of the small start-up is that it may offer the potential for higher returns. In addition, the small start-up may not pay out dividends - it may need to reinvest any profits back in the company, whereas the larger, more established corporation may offer attractive dividend payouts.
How much should I invest in shares?
It's important to be clear about your investment goals and risk profile before buying stocks and shares. Don't use cash you will need in a hurry, as that might mean you had to sell your shares at a loss rather than hold them and hopefully see them grow in value over the long term.
You should only invest money that you can afford to tuck away for five years or more. The stockmarket is not a good home for short-term cash – you are better off keeping your emergency savings in an easy- access deposit account.
It's important to research any companies you intend to buy shares in to ensure they offer a suitable investment opportunity for you. The value of shares may increase as company profits increase, or as a result of market expectation, but the opposite is also true. The value of a share may fall, and if a company collapses, you may lose all of your original investment.
The risk of this happening depends on the profile of the particular company you want to invest in, but there's no certainty about the outcome of an investment in shares, unlike a fixed-interest deposit where you are certain of getting your capital back and earning a fixed rate of interest.
How do I buy shares?
You can buy shares directly from a stockbroker or online trading platform, or you can buy shares through an investment fund. An investment fund pools your money with other investors and it also invests in shares in the stock of many companies.
Because a fund has built-in diversification, the risk is spread and is therefore generally lower than buying shares in a single company. You can also choose a fund that matches your risk profile, but an investment of this type is not risk-free - you're still exposed to the risk of the stock market falling in value.
How do I buy shares on a trading platform?
First you will need to open an account with an online stockbroker. By using a trading platform you can choose the stocks, shares or funds that you want to buy and carry out an electronic trade. You will need to have money in your account before you can begin to trade – you can’t trade on credit.
You can search for the shares you want to buy and put in an online trade instruction. You will receive an electronic contract note to confirm this has been carried out. Normally you can only trade during stockmarket opening hours, which are 8am to 4.30pm Monday to Friday. You can pre-order trades outside these times, but the price will not be confirmed until the stockmarket reopens.
How do I sell shares?
It's simple to buy and sell shares if you have a trading account. You can sell shares electronically by putting in a sell order in your online account. Some investors still have a personal stockbroker to call in order to buy and sell shares, but this is generally a more expensive option than an online stockbroking service, because the trading and commission fees will be lower.
When buying shares you will have to pay a government tax known as Stamp Duty, which is normally equivalent to 0.5% of the transaction.
You will also have to pay commission to your broker, fund platform or online trading platform when you buy or sell shares. It pays to shop around to find a low cost broker, especially if you are planning to trade frequently, because high charges can quickly start to eat into any profits you may make.
How do stockmarkets work?
Stockmarkets are a place where investors buy and sell shares. Different countries have their own stockmarket where their companies are registered. In the UK, the London Stock Exchange is the place where UK shares are traded.
Stockmarkets match buyers and sellers of shares and other financial products. If supply outstrips demand, for example more people want to sell their shares than buy them, then the price of the shares will fall. Sometimes stockmarkets rise or fall because of the sentiment of investors – that is, they are influenced by economic or political news rather than the underlying health of a company. If there is a sudden stockmarket fall, even good qualify profitable companies may see their shares decline in value.
How do I invest?
You can invest by opening a trading account with an online trading platform, or you can open an Individual Savings Account (ISA) and buy shares within your ISA.
You can invest in funds, either within or outside an ISA, via a fund supermarket. This is a type of online broker which gives you access to hundreds of different funds at a low cost.
What is an ISA?
An ISA, known as an Individual Savings Account, is a tax-free wrapper into which you can invest your savings.
You can invest in shares by opening a Stocks and Shares ISA, and you can invest in cash with a Cash ISA. You annual ISA allowance is £20,000. This means that if you want to invest in shares you can invest up to £20,000 in the 2020 to 2021 tax year in a Stocks & Shares ISA.
All underlying growth (capital growth) is tax free within an ISA, as is any income or dividends from the shares or funds that you hold within the ISA.
When do I have to pay tax on stocks and shares?
- Dividend income and tax If you hold shares within your ISA, you will not need to pay any tax on the dividends you receive.
- Sale of shares and capital gains tax If you dispose of an asset for more money than you bought it for, you are said to have made a capital gain, or in more familiar terms, a profit. The gain you make - not the amount of money you receive for the asset - is liable to capital gains tax (CGT) if you hold the asset outside an ISA.
If you receive dividends from shares that you hold outside an ISA, you may have to pay tax. You can earn dividend income each year without paying tax, and this is known as your dividend allowance. In the 2020 to 2021 tax year the dividend allowance is £2,000.
Under the current tax rules for the 2020 to 2021 tax year, each adult has an annual CGT allowance of £12,300. If you make gains of more than this within the tax year you will have to pay tax. You may be able to reduce your tax bill by claiming reliefs or deducting losses you have made on the sale of shares.
The tax rates on Capital Gains depend on whether you are a higher rate taxpayer or not. You pay tax at 20% if you are a higher rate taxpayer and have made gains above your annual CGT allowance. You pay CGT at 10% if you are a basic rate taxpayer and have exceeded your CGT allowance for the year.