What is the stock market?
A public company’s shares are listed and traded on regulated stock exchanges such as the UK’s London Stock Exchange (LSE). London ranks as the world’s second-largest financial centre after New York City, and LSE is among the top five stock exchanges worldwide.
FTSE 100 is the UK’s main equity index, comprising the top 100 businesses on the LSE by market capitalisation. It may also be referred to as the “Footsie.”
In general, an index comprises different companies, and comes with its own rules. Most companies found in the FTSE 100 are well-known multinational conglomerates.
However, these names are reviewed every quarter. Following the review, some companies leave the index and get replaced by others.
This important index was launched in January 1984 at an initial base value of 1,000 points. In January 2022, the index was around 7,500.
By comparison, the UK’s other leading index, the FTSE 250 index, is made up of the 101st to the 350th largest firms on the LSE. FTSE 250 members typically have a more domestic focus in business operations. This index was launched in October 1992.
You can invest in stocks of companies listed in both the FTSE 100 and FTSE 250. In addition, the Alternative Investments Market (AIM) of the LSE offers a platform for smaller companies to access capital so that they can grow their businesses. You can also buy individual shares of AIM-listed businesses.
You can also buy stocks of non-UK companies listed on exchanges in different countries. For example, many investors buy shares of US-listed companies.
In most cases, your UK-based brokerage account should allow you to invest in overseas stocks. The process is typically similar to buying UK shares.
How to invest in stocks and shares?
Before investing in the stock market, you need to familiarise yourself with basic terminology. First of all, the two terms “stocks” and “shares” are generally used interchangeably, meaning a unit of equity (or ownership) in a business.
Investing in stocks requires buying shares of a given company’s stock to make a profit within a period of time. This profit can come from earning dividend income as well as capital gains through share price increase. Thus, if you decide to invest in stocks, you typically aim to see higher returns than savings rates offered by bank accounts.
First of all, you need to decide how you want to invest in stocks. In the UK, as in most other countries, you can either purchase the physical shares of a company or funds that offer a basket of shares in different businesses.
With a bit of research, you can decide which shares are most appropriate for your portfolio. Investing in shares means having ownership in a company, however small your percentage is.
Therefore, it is important to understand what you are buying and then to review your stock portfolio regularly. If you are a new investor, you may want to start with established companies that grow their earnings constantly. They should be names that you want to have in your portfolio for years, if not decades.
If you are not certain how to begin investing, you could also consider buying a low-cost fund that tracks the returns of the FTSE 100 or a FTSE 250 tracker fund. Such index trackers follow both the up and down moves in the index they track.
Here are several examples of FTSE 100 and FTSE 250 tracker funds:
|Fund Example||Index Followed||Ongoing Charges Figure (OCF)|
|HSBC FTSE 100 Index Class C – Acc.||FTSE 100||0.06%|
|iShares 100 UK Equity Index Fund (UK) Class D – Acc.||FTSE 100||0.06%|
|FTSE 100 Index Unit Trust – Acc.||FTSE 100||0.06%|
|iShares Core FTSE 100 UCITS ETF||FTSE 250||0.07%|
|FTSE 250 UCITS ETF (VMID)||FTSE 250||0.10%|
Another possibility for most investors is to buy a fund or investment trust. In that case, fund managers professionally select shares.
They may base their decisions on a specific investing style—such as value or growth. Or they may invest by sector—such as energy, healthcare, real estate, or technology.
Fund managers may also decide to invest in companies by market capitalisation (cap). However, such specialised funds and trusts typically cost more than index trackers.
You should also familiarise yourself with Individual Savings Accounts (ISAs), which are legal tax-wrappers around a range of investments. Since their introduction in 1999, ISAs have become popular among UK residents.
Each tax year, which runs from 6 April of the preceding year to 5 April of the current year, there is a maximum amount that an individual can put into an ISA. In the 2020 to 2021 tax year, the maximum subscription allowance for an adult was £20,000.
There are currently two types of ISA that allow you to invest in the stock market:
|ISA Options||Annual Limit||Features|
Stocks and Shares ISA
|Allows you to invest in a range of shares, funds, investment trusts and bonds. |
You do not have to pay income tax or capital gains tax on the money that you earn.
Lifetime ISA (LISA)
|Can hold cash or stocks and shares. |
For each £4,000 that you invest, you will receive a 25% government bonus on all savings.
If the stocks and shares option is chosen, instead of earning additional interest on top of your savings and government bonus, you will invest your money in funds over time.
In addition, there are also Junior ISAs that parents can open for children aged 0-15.
You can think of ISAs as tax-efficient vehicles for your lifelong investments. When you invest within an ISA, you do not pay income tax on capital gains or dividends.
You could use (part of) your annual allowance in a Stocks and Shares ISA. You need to invest that amount by 5 April, which is the end of a given tax year. The unused allowance from this tax year does not roll over to the next.
In a Stocks and Shares ISA, you can invest in stocks, index trackers, as well as funds. Stocks and Shares ISAs can also be called investment ISAs. The legal tax protection from an ISA wrapper is lifelong.
A self-invested personal pension (SIPP) also offers certain tax advantages as you save for your golden years. However, SIPPs also come with certain conditions which you should find out before making a long-term commitment.
Where to buy stocks in the UK?
In order to trade stocks or buy funds, you need to have a share dealing (or brokerage) account, which can be opened online, at a bank, or with a specialist stockbroker.
The type of brokerage account you open will depend on your circumstances and goals. Your account is the portal to the world of investing. Therefore, it is important to familiarise yourself with the type of securities offered, as well as commissions and other potential charges.
For instance, some brokers may waive certain charges if you execute a minimum number of trades per month. Others may waive fees if your account size meets a minimum threshold. In addition, you can typically open a Stocks and Shares ISA with UK-based platforms or brokers.
Type of brokers
Ways of buying shares in the UK have evolved, especially in the past decade. Now, a large number of people use an online investment platform or a trading app.
But you can also still invest in shares of publicly listed companies through banks, specialist brokers, financial advisers, as well as other financial institutions such as fund supermarkets and building societies.
- Online platforms
These popular tools have become many investors’ gateway to a range of asset classes, such as stocks, tracker funds, or investment trusts. Many platforms also allow you to invest not only in UK shares but also international ones as well.
- Fund supermarkets
If you are mainly interested in funds, then you could use a fund supermarket. It is a type of brokerage that offers a wide range of funds with different themes or asset classes. Funds can also have a domestic UK focus or alternatively provide exposure to international shares.
- Building societies
You can also use building societies, which are also referred to as ‘mutuals’. They are financial institutions owned by members, who have a say in operations. Unlike most banks, these financial firms are not public companies listed on the stock exchange.
Instead, they operate for the benefit of members, as opposed to shareholders. Many of these building societies also offer a range of products and services that could appeal to those who want to invest in shares.
Investment objectives are important
The type of financial institution to use generally depends on your investment objectives and prior experience in investing. For instance, the London Stock Exchange differentiates between three types of member firm brokers, namely execution-only, advisory and discretionary.
If you do not want advice about investment products or shares, execution-only financial institutions would be your first choice. Nonetheless, you should do due diligence as to their suitability for your financial objectives.
Online trading platforms or share trading apps would typically be execution-only. Their brokerage fees are low, and many also offer commission-free trading.
But they generally do not provide financial research. These online platforms and apps are appropriate if you want a do-it-yourself approach without access to advice.
- Advisory firms
On the other hand, advisory firms provide information about assets and offer guidance as to their suitability for an investor’s portfolio. For example, they discuss the outlook for a given stock and how it might fit within a long-term portfolio.
However, the final investment decision still rests with you since an advisory firm cannot act without the client’s permission.
- Discretionary accounts
Next are discretionary accounts, which allow the financial institution to trade on behalf of the client. In other words, you do not need to give consent before each investment and trade.
However, when you first become a client, the firm discusses your investment objectives, when you specify your parameters clearly. Discretionary accounts are managed in accordance with your aims and wishes. The firm typically holds regular reviews with you to discuss your circumstances and changes that might have happened in your investment objectives.
Opening and funding your brokerage account
To open a brokerage account, you will typically need your personal details, address, proof of identification, and National Insurance (NI) number. Some brokers may also ask about your employment status and source of funds.
You may fund your account with a lump sum amount. Or alternatively, you may link it to your bank account, such as via direct debit, to make regular contributions.
After adding funds to the brokerage account, the next step would be to select the stock or funds you are interested in buying. Then you would put an order to buy that financial instrument.
Finally, before opening an account, you should ideally ensure that your UK stockbroker is regulated by the Financial Conduct Authority (FCA) to protect your transactions.
How to sell stocks
Depending on the type of share dealing account you have, you can either sell the stocks in the portfolio online or work directly with a financial institution or broker. You can sell using either a market order, limit order or stop order.
Should I invest in stocks?
Risk and Return
Before buying shares in the stock market, you should realise that risk and return are two sides of the coin in investing. Therefore, it is crucial to determine your investment goals prior to committing capital.
Different people have a somewhat different risk/return tolerance or profile. Therefore, you may want to discuss your circumstances with a registered financial advisor.
Time in the market
You should not consider putting capital into stocks unless the investment horizon is at least five years. The longer the time in the market, the easier it would be to ride market swings.
In other words, you should not invest any money you might need in a few months or even years. There could be an unexpected event leading to market declines at any moment. Then, your patience or even faith in your investments could be tested.
Right investment decisions do not necessarily come from constantly choosing winning stocks and funds. Instead, they come from owning shares as part of a long-term investment strategy. When you have a long-term portfolio made up of robust shares, you can avoid getting caught up in a potential short-term panic selling.
Timing market swings is difficult
On the other hand, a long-time approach to investing means any market decline could be an opportunity to buy quality stocks at lower prices. History reminds us that events, such as economic slumps, that might initially lead to market declines, eventually come to an end.
Then, robust shares start a new bull run and make new highs. However, timing such market swings is nearly impossible, even for professionals.
Therefore, a buy-and-hold approach to stock investing is more appropriate for most people. You can potentially see your nest eggs grow significantly over decades by diversifying your investments among different quality shares.
How much money do you need to invest?
Investing is a personal decision that depends on your financial position, as well as life events at a given moment. First of all, you should appreciate your tolerance for risk. It is also crucial that the investment capital is separate from the everyday spending pot and emergency fund.
Many financial planners suggest that an emergency fund should account for at least a quarter of your annual living expenses. That way, you do not have to dip into a stock investment if there is an urgent need for cash.
Once you are financially ready to invest in shares, you can invest as little or as much as is suitable for you. For example, most investment platforms allow individuals to start stock investing with as little as £1.
You may also decide to contribute small amounts into the investment pot regularly. For instance, a certain amount of your monthly salary could be automatically transferred into the brokerage account.
You might prefer such an approach instead of depositing a lump sum in one go. When you invest regularly, you do not worry about short-term price swings, either. In other words, there is no need to try to time the market.
Finally, a regular review with a financial planner might be helpful. As your financial priorities change, so could your portfolio. Similarly, what is right for another investor might not be appropriate for you. Therefore, an individualised review could help you achieve your investing goals more easily.
How much money can you make from stocks?
Investing in stocks should ideally be a long-term strategy to grow your wealth, especially for later years. Therefore, you should not approach it as a get-rich-quick scheme. There will be consecutive years when stocks do well. But then, there could also be months or even years when broader markets are down.
Historically, buying-and-holding shares in companies that consistently grow earnings is the key to creating wealth in the stock market. Decades-long average numbers show us that over time the FTSE 100 index returns have been around 7%-8% per year.
However, an important part of those returns has come from dividends offered by robust, blue-chip companies. Over the past decade, the average dividend yield for the FTSE 100 has been about 4%.
So in addition to enjoying capital growth, you can also receive regular passive income from well-established companies in the form of dividends. For example, many members of the FTSE 100 index pay regular dividends. These businesses usually generate robust cash flows, enabling them to increase dividend payouts over time.
In addition, stock prices of dividend-paying companies are typically less volatile. In most cases, you would not consider selling shares that create passive income in a hurry, for example when there is a market decline.
The stock market is not a place to get rich overnight. Instead, investing in shares could enable you to grow your capital significantly over decades. Compound interest can help you turbocharge your portfolio over a long investment horizon.
In the table below, we look at how £10,000 grows over 35 years with and without compound interest.
£10,000 invested and earning returns of 5% a year
|End of Year||£ Value of Investment With Compounding||£ Value of Investment Without Compounding|
Market history is full of tales of numerous economic downturns or global political uncertainties that have led to market declines or crashes, Yet, in most cases, within several months, a large economy such as the UK has turned around and even continued to reach new highs..
You should therefore appreciate the importance of holding shares of quality companies, and making contributions into stock market accounts regularly and over decades.