Investing in the stock market isn’t difficult. But if you’re new to investing, the jargon can be a bit confusing.
To start with, what exactly is a stock? Are stocks and shares the same thing?
In this article I’m going to take a step back from picking stocks, and focus on the basic ideas involved in stock market investing. I’ll then finish up with a couple of suggestions that could help you get started on your investing journey.
What are stocks?
Stocks and shares are the same thing. US investors tend to refer to stocks. In the UK we usually talk about shares. Stocks and shares are also known as equities.
A share represents fractional ownership of the company which issued the shares.
For example, if a company issues 100 shares, this represents its share capital. If you own one share, you are entitled to 1/100 (1%) of the company’s earnings and assets.
When a company issues new shares, it sells these directly to investors in order to raise money for its operations. But when existing shares are bought and sold by investors, the company doesn’t receive any of the cash.
It’s a bit like the difference between selling new cars and selling used cars.
How can you trade in stocks?
The stocks we talk about are mostly those of publicly-traded companies, such as oil and gas giant BP.
Shares in such companies are traded on stock exchanges such as the London Stock Exchange. These are public markets where anyone can buy or sell shares.
To buy or sell a stock, we have to use the services of a broker. Your broker will arrange the trade to ensure that payment and ownership of the shares are transferred reliably between buyers and sellers who don’t know each other.
The share price is set by the market at a level where supply and demand are balanced. The price changes all the time, based on the number of buyers and sellers seeking to trade the stock.
What do you get from owning a share?
Although you’re the part-owner of a company, you don’t have any direct control or ownership of the operating business. Shareholders vote to elect a board of directors, which is responsible for running the business.
Shareholders are entitled to a share of profits, which may be paid out as a cash dividend or retained for future use. If profits are retained, then the share price may rise to reflect the business’s growing wealth.
What do you really own?
As a shareholder, you own shares in the company. The company itself owns assets such as factories and equipment. This legal separation is important, because it also means that you are not responsible for the company’s debts.
This is known as limited liability. It’s a very important idea.
Limited liability means that the value of the shares you own can fall to zero, but you will never have any other financial obligations toward the company.
Getting started
Historically, the UK stock market has outperformed cash and government bonds. I think it’s a great way to build wealth. To start investing, I’d choose a simple index tracker fund.
If you’d prefer to invest directly in individual companies, I’d aim for a balanced portfolio of FTSE 100 dividend stocks. These should provide a reliable income and long-term growth.
