Investments

How do stock markets work?

At a basic level, the stock market is a marketplace where buyers and sellers make trades on shares, or stock, in companies.

Companies sell shares to raise money so they can build and expand their businesses.

When you invest in the stock market, you buy shares in a company or companies, with the aim of making a profit.

As an investor, or shareholder in the company, you can sell your shares to anyone who wants to buy them or buy more on the stock market at any time.

The price of a company’s shares can increase and decrease according to supply and demand.

When a company grows, performs well and is profitable, or if City buyers predict it will do well, there’s more demand for its shares. So its share price on the stock market will rise.

Similarly, if a company’s profits drop, or if it’s expected to struggle, then demand for its shares will fall, and so its share price will lower.

Other factors, like the general performance of the economy and world events can also affect share prices. For instance, the war in Ukraine and Covid-19.

Historically, stocks and shares have outperformed savings accounts when it comes to returns.

But the stock market can be volatile, so although your investment could make you a profit, there’s the potential that you could lose money too.

What is a fund?

If choosing and buying your own shares sounds too daunting, then you could opt for an investment fund, which you can buy into on an investment platform. It’s an easy and convenient way to invest and it’s how lots of people first dip their toes into the investment world.

With an investment fund your money is pooled with that of other investors and a fund manager uses it to buy collective investments of stocks, shares, bonds or other assets on your behalf.

Because your money is spread and invested in lots of different assets within a fund, it’s considered lower risk than investing in just one company.

It means that, if one of the companies you have shares in performs badly, then - hopefully - the shares you have in other companies within the fund will perform well enough to make up for your losses.

You can choose from active funds, where a fund manager actively manages your fund, analysing the market and buying and selling shares in response to it, or passive funds that track a stock market.

Most platforms offer a range of ready-made portfolios which package up a diverse selection of investments managed on your behalf by fund managers.

You just need to choose the level of risk you’re happy with and you can opt for different types of fund - such as those specialising in things like sustainable companies that have higher environmental, social and governance (ESG) scores.

You can be charged platform fees, fund-management fees and transaction fees when you invest in a fund, so be sure to check and compare these charges across different products.

Find the right investment ISA for you.

There are lots of different types to choose from, including:

Stocks & shares ISA

With a stocks & shares ISA your money is invested in things like shares, funds and bonds rather than held in cash, as it is in a cash ISA. Like a cash ISA, any gains you make from your investment are free from tax.

Currently, you can invest up to £20,000 per tax year (April to April) - this is known as the annual ISA allowance and the amount can change from one financial year to the next.

When you’ve chosen a platform or provider for your ISA (from your bank, an investment company or online platform) you can either choose what stocks and shares you want to invest in or opt for one run by a fund manager.

Charges will vary depending on which company you open an account with and the type of ISA you opt for.

Unlike cash ISAs, with a stocks & shares ISA there’s an element of risk because the value of investments can fall as well as rise. So you may get back less than what you invested initially. To minimise risk, you should be prepared to commit to one for the long-term, at least five years.

Stocks & shares lifetime ISA

This type of ISA is available to people aged under 40 and is designed to help you save to invest in your first home, or towards retirement.

You can save up to £4,000 a year, get the tax-free benefits on interest of an ISA and the government also pays you a 25% bonus - in other words £1 extra for every £4 you save.

You can keep paying into a lifetime ISA until you’re 50, and get the government bonus, but retirement funds can’t be claimed until you’re 60. Withdrawing money for reasons other than buying your first home or when you’re over 60 means you’ll lose the government bonus, and you’ll have to pay a 25% charge on the amount you withdraw.

Stocks & shares junior ISA

Junior ISAs - which replaced Child Trust Funds – allow friends and family of a child to pay into a tax-free account each tax year.

This tax year the Junior ISA allowance is £9,000.

Your child can’t access the funds until they reach 18, then the junior ISA will convert to a standard Isa and they’ll have control over the money to use as they wish.

How safe is my money in equity investments?

It’s when you invest in a company by buying their shares.

You can buy individual stocks from a company or buy them in ‘baskets’ of multiple types of stocks from different companies in an equity fund.

Equities are considered the riskiest class of assets because stock markets are volatile and can move up and down rapidly.

The risks are especially high if you purchase individual stocks because if the company you’ve bought into fails, you could lose all your money.

There are lower risks attached to an equity fund because you’ll own shares in multiple companies. So if one company fails, then the performance of other shares in the fund might make up for your losses.

Plus, risk will vary depending on the type of stocks or funds you invest in. Putting your money into emerging markets will be riskier than investing in companies in the FTSE 100, for example.

How much should I invest for my retirement?

The earlier you begin investing or saving for your retirement, the more your pension pot is likely to be worth when you retire.

Some financial experts suggest putting away about 15% of your annual pre-tax salary if you start saving in your twenties.

But it’s never too late to start. Even if you’re over 50, you can boost your pension pot by contributing larger sums of money into your fund every month. Or you can think about delaying your retirement until your pension funds are larger.

Some ways to save towards your retirement include opening an ISA, paying into a high-interest savings account or building an investment portfolio.

The most popular way to build up a pot of money to provide an income for your retirement is to save into a pension.

If you’re an employee, you may have a workplace pension, into which your employer also makes contributions.

But if you’re self-employed, for example, or don’t have access to a workplace pension (or if you want to have a pension in addition to your workplace pension), then a private pension, also known as a personal pension, or SIPPs could be the way to go. The government boosts your contributions through tax relief.

A personal pension is administered by a pension fund manager who picks the investments, while SIPPs give you a more hands-on approach to managing your pension, and more choice over how and where you place your investments.

How much should I invest?

You don’t need to have a lot of money to have a go at investing. Most platforms and banks allow as little as a £50 lump sum or £50 monthly payment to open an investment account with them.

Of course, the more you consistently contribute to your investment fund, the higher the potential returns over time.

Always ensure you have a reserve fund of money in place before you invest, though. Most financial experts suggest that you keep enough money in an easy-access account to cover between three and six months’ income, so you can dip into it should something unexpected happen, like if you’re made redundant from your job, or you need to buy a new car.

What do I need to know before I start to invest?

Though investing can mean better returns than you’d get from a savings account, it’s also a risk because there’s the chance you’ll get back less money than you put in.

High-risk investments potentially offer the greatest returns, but they also carry a higher risk of losses.

Having a diverse portfolio of investments is better than putting all your money in one place as it can mean less of an impact on your money if one of your investments doesn’t do well.