What even is a stock anyway?
Scrolling through social media you might come across a fairly common news headline like “BREAKING: Stocks fall by over 300 points”.
Anyone in their right mind might think, well what does that mean? What’s a stock and why should that matter to me? Is a 300 point another financial crisis or something that’ll be reversed by tomorrow?
Stocks, shares and equities: the same thing
If you’ve thought about opening an ISA for your savings, you can either open a Cash ISA or a Stocks & Shares ISA which allows you to invest your money for future returns in things like equities – also called stocks and shares. After all this is the finance industry, why use one word for something when apparently three will do…
Stocks are small pieces of a company you can buy, meaning that when the company does well, so does your investment.
You can invest in these directly and you, or your adviser, decide which individual companies you would like to hold. Alternatively, investing in a fund alongside other peoples’ savings allows you to hold several shares at once, saving you a lot of time and hassle. This can also help lower your risk because one company which might perform poorly is less likely to drag down your whole investment.
How can you make money from stocks?
At the most basic level, your investment in these companies will do well if they are worth more when you want to sell than when you originally invested. You can measure this by looking at a stock’s price performance over time. Let’s take the three largest companies in the world: Microsoft, Apple and Amazon. £100 invested in the stocks of any of these companies 10 years ago would be worth many more times that today – this gain is what’s known as ‘capital growth’.
Figure 1: The giants
Source: Thomson Reuters, data as at 14 December 2018, rebased to 100 as at 1 January 2009
Please remember past performance is not a guide to future performance.
As always, it’s important to remember that there is a risk in investing – for every Apple and Amazon there are many more unfortunate companies which failed! The value of equities will vary, causing fund prices to fall as well as rise, so you might get back less than the original amount you invested.
The other way stocks can make you money is through income paid to you by the companies in the form of dividends, kind of as a thank you for being a shareholder and to show that the company is performing well and making money. A company’s board of directors make the decision about how much, if any, should be paid out to shareholders. Some funds have a special focus on those companies which consistently pay out dividends to investors, often called ‘equity income’ funds.
Are stocks right for me?
Before investing in anything, you should think about your investment time horizon. Over long time periods, stocks have delivered incredible returns but due to their constant ups and downs they might not be suitable if you need to sell your investment in just a few years. But if you’re investing for a long time, say for your retirement or more than 10 years, investing in stocks even through a financial crisis can be beneficial as you’ll be buying good companies while they’re unfairly cheap.
Compared to other types of investment such as bonds, property or plain old cash, equities have performed better but are typically a more risky place to put your money. There’s a reason why multi-investment funds have more equities if they are looking for higher returns than those which are more cautiously positioned.