Most of us have heard of stocks and shares but don't know how to buy shares or how to buy stocks. We explain the process of investing in shares and stocks in this guide.
Continue reading to learn more about shares, why investing might work out, and why it might not, and how to get your head around the taxes surrounding shares.
What are shares?
Also known as equities, a share represents a share of ownership in a company, and these shares are listed on a stock exchange. When you find a share to buy, you are buying a small stake in a company. You become a joint-owner of the company along with all the other shareholders, and you are invited to have a say in a number of the decisions the company makes.
When looking to buy shares, the aim is for the shares to grow in value over time; and also to benefit from a share in the profits of the company in the form of regular dividend payments. Shares give investors the opportunity for a steady income and capital growth, although neither of these is guaranteed.
Why invest in stocks and shares?
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.
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.
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're 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 blue chip 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.
It's vital to clarify your investment goals and risk profile before buying stocks and shares. 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 is 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?
Even if you understand how shares work you may still be asking yourself 'how do I buy shares?'
You can find shares to buy directly from a stockbroker or trader, 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.
When do I have to pay tax on stocks and shares?
- Dividend income and tax - Dividend income is subject to tax. The dividend ordinary rate of 7.5% applies if you are a basic rate taxpayer, a rate of 32.5% if you earn up to £150,000 and 37.5% if you earn more than that. However, when you receive dividend payments a percentage of tax has already been paid, this appears on your dividend voucher as a tax credit. If you're a higher rate taxpayer you will have an outstanding tax liability on the dividend payment of 32.5% which is payable when a personal tax return is completed but after the tax credit is applied, this will be in reality 25%. An exception to these tax rules is dividends from ISAs (including ISAs that were previously PEPs), which are tax-free.
- Sale of shares and capital gains tax - If you dispose of an asset for more money than you bought it for, you're 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 tax at a rate of between 18% and 28% for higher rate tax payers. Capital Gains Tax applies to the disposal of stocks and shares. Before any tax is payable though, you have an annual tax-free allowance for Capital Gains Tax, which is £10,900.