How to invest in the stock market: a beginner's guide
To a beginner, the stock market can appear rather daunting. But equities outperform cash and bonds over most medium and long-term periods and easy routes in are not hard to find.
In reality, with dismal returns on offer from banks and building societies, investing in shares provides an opportunity to hedge against rising inflation and achieve greater returns than cash, bonds and property.
The basics of investing
In the UK, the main stock market is the London Stock Exchange, where public limited companies and other financial instruments such as government bonds and derivatives can be bought and sold.
The stock market is split into different indices - the most famous in the UK being the FTSE 100, comprising the largest 100 companies.
The most well-known indices come from the Footsie group - the FTSE 100, the FTSE 250, the FTSE Fledgling and the alternative investment market (Aim), which mainly lists small and venture capital-backed companies.
There are two ways to access the stock market: directly and indirectly. Although 'directly' is a misnomer - investing in the stock market is always done through a third-party broker - direct investment means buying the shares in a single company and becoming a shareholder.
There is a wide range of broker services available. Some offer bespoke services and tailored advice, such as Charles Stanley, Redmayne Bentley and Killik & Co, whereas others are execution-only share dealing services.
These are online platforms where a client can buy and sell shares independently through a share dealing account without being offered advice. Examples of these include Interactive Investor, Hargreaves Lansdown and The Share Centre.
'For beginners who want to be more involved and dabble with individual shares, it makes sense to open an online, execution-only share dealing account, which keeps the cost of investing to a minimum,' says Martin Bamford, managing director of Surrey-based IFA Informed Choice.
He adds: 'When you are getting started, it makes real sense to buy blue-chip company shares on the LSE and hold them for several months. Regular trading will kill profits quickly, with the cost of buying and selling shares exceeding the returns you can make from a small starting stake.'
You can find the best online broker for your portfolio size thanks to our comprehensive list of the 24 major investment platforms and run down of their costs and tools.
Reading the financial press can be useful in terms of choosing which shares to buy, Bamford adds. 'There are also plenty of internet forums where share tips can be found.
'Don't part with your money to receive share tips, as there is plenty of useful free information in the public domain. Stick to companies you find interesting and spend the time researching a company before you invest.'
Money Observer is a good place to start, as it lists the full performance, along with yield and price/earnings ratio, of shares listed on the major FTSE indices each month; as well as performance for funds, trusts and exchange traded funds - more on those later.
An indirect approach is a more common way of accessing shares, as it spreads risk by investing in a number of companies.
This can be done via an open-ended fund, such as an Oeic or unit trust, which is made up of shares typically from between 50 and 100 companies, and can be sector, country or theme specific. Money in these funds is ring-fenced away from the fund provider, so if the firm defaults, the money is still safe.
An investment trust is another pooled investment, but it is structured in the same way as a limited company. Investors buy shares in the closed-end company, and it is listed on an index in the same way as a company such as Tesco or RBS. Trusts are less numerous than funds, but often have less expensive management charges.
'Beginners are best suited to using collective investment funds to access the stock market,' adds Bamford. 'This enables them to use the collective buying power of a fund to reduce charges on a small starting portfolio.
'They also get access to a professional fund manager to buy and sell individual stocks, rather than having to make these decisions on their own.'
While most investment funds and trusts are actively managed products, run by a fund manager who handpicks stocks and has some direction over the performance of the fund, most exchange traded funds (ETFs) are passive products.
In this sense they simply aim to replicate an index such as the FTSE 250. As index-linked products, they can access almost every area of the market.
ETFs may be cheaper than funds or trusts, as there is no active manager to pay for. However, as they simply track an index, if the index falls spectacularly, so will your investment.
All the investment vehicles described above can be accessed through a broker or fund platform, directly through the asset manager or through a wrapper such as a stocks and shares Isa.
For a closer look at execution-only fund platforms to help you choose the right one for your circumstances, click here.
As for more complicated investments, Bamford has some words of advice for beginners: 'Leave spreadbetting and day trading to the professionals, as these can be high-risk ways of investing money.'
A fund-of-funds or a multi-manager fund, which is a single fund investing in a range of others, can be a good starting point for novices, as it demands little involvement from the investor.
'These funds are proactively managed and investors can choose a risk profile that suits them, so they are secure in the knowledge that the investments are in line with their expectations,' says Peter Chadborn, founder of Colchester-based IFA Plan Money.
However, these types of funds are generally more expensive than sole-managed investment trusts and funds.
Money Observer compiles a hand-picked list of Rated Funds chosen on the basis of performance and consistency, although of course we cannot guarantee performance. For the full list of Rated Funds click here.
What to be aware of before investing
There are several things that investors should be aware of before committing money to the stock market.
'As a starting point, you need to decide what you want to achieve, how long you are planning to invest for and how much risk you are prepared to take,' says Patrick Connolly, certified financial planner at Chase de Vere, 'as this will help you decide which investments are appropriate.'
Tales of other people's huge gains can be tempting, but the market won't always go in your favour and you must be prepared to see your investment drop as well as rise.
'You must understand your tolerance to risk rather than appetite for reward. Risk and reward go hand-in-hand, and any investor must consider the potential downsides before investing,' says Chadborn.
'Secondly, investors must understand the structure of the investment: look at the fund factsheet rather than the glossy marketing material,' he comments. 'The factsheet will tell it warts and all, rather than what the company wants you to see.'
The costs involved in buying funds, trusts, shares or ETFs can vary hugely, and higher fees can easily eat away at future returns. To ensure value for money, Chadborn highlights the importance of comparing charges on different products.
'By buying directly from a fund supermarket, you'll benefit from reduced initial charges on funds, compared with a big retail outlet like a bank.'
That said, discount supermarkets and execution-only brokers don't offer advice, so for a novice investor, it may be better to seek independent advice from a financial adviser before making any investment decisions.
Without the help of a crystal ball, timing the market is impossible. Instead, look to invest regular premiums on a monthly basis rather than a depositing a lump sum into a fund.
By drip-feeding money in, it's possible to negate the risk of market timing - if the market falls, the regular premium will simply buy shares at a cheaper price the following month.
'Don't get swayed by investments just because they are at the top of the performance tables,' warns Connolly. 'Strong recent performance should be seen as a warning sign, as the investment gains have already been made, rather than as an opportunity to buy.'
The final key point is that investments should be held for at least five years to smooth out any bumps in the market, but that doesn't mean once they're bought they can be left unchecked.
Connolly concurs: 'Review investments every six months to ensure they are performing in line with expectations. If they aren't, try and understand why and then look to make changes if appropriate.'
We make every effort to ensure our beginner's guides are kept up-to-date. However, in the constantly shifting environment of investment and financial services, occasions may arise where elements of a guide become out-of-date. Please double-check the facts before taking any important financial decisions.