By Alex Wong
Investing can be daunting, especially for those that are new to the topic. Typically a jargon-filled industry, the idea of using your money to buy assets that may drop in price is often likened to gambling. Whilst there is an element of risk to making investments, building your understanding of the different terms, strategies and concepts used in investing can help you to better invest yourself. If you are new to investing and not sure where to start, be sure to read our Beginners Guide to Investing.
It is widely accepted that there are five different asset classes when it comes to investing;
In this series I’ll take a look at each of these assets; explaining what they are and hopefully helping you to get your head around the differences.
The first financial product that we will discuss is equities; equities appear frequently on the websites of investment firms around the financial world, but what are they and how do they work?
What are Equities?
Equities, or more commonly known as ‘Shares’ and are used to indicate part ownership of a company. For example, if someone says ‘I have bought shares in Netflix’ they have purchased Netflix equities – in essence, they are a partial owner of Netflix, which is more commonly known as a ‘shareholder’. Equities are seen as being the riskiest asset of the five classes mentioned above. This is because share prices are subject to large changes in the stock market on a daily basis. The higher the volatility of a share, the riskier it is.
The terms “stocks” and “shares” are often, and can be, used interchangeably. Shares however is usually used to refer to a stake in one company, whereas stocks refers to ownership in more than one company. For example, if I told someone that I had 100 shares, they would be inclined to ask in which company, whereas 100 stocks would refer to 100 different companies.
Why do people buy shares?
When people purchase shares, they are usually looking to make gains through two different avenues:
1. Share price increase
The main reason people purchase shares is that they believe that the price of that share will rise. As the share price of a company increases, the value of the position that the investor owns also increases. If the share price increases and the owner then sells their share, the difference between the price bought and price sold will be their profit.
Dividends are a portion of a company’s profit which is paid out to shareholders. Dividends are paid per share so the more shares you own, the higher the total amount of dividends you receive. It is a way for a company to ‘give back’ to its investors by paying them a dividend on each share they own.
How does the share price change?
The price of a share or the ‘share price’ is driven by the supply and demand for the stock – more simply, if there are more buyers (demand) for a stock than sellers (supply), then the price will increase. Supply and demand on the stock can be influenced by a number of factors, including global and company specific news, rumours around the company and its operations or products, and market sentiment, which is the overall investor attitude towards a financial market. Conversely, if there are more sellers (supply) than buyers (demand), the price will decrease. To take a very simple example:
I own 1 Netflix share with share price at £1.
Share price increase
If there is high demand, there may be 3 people who want to buy my Netflix share, it is likely that one of the 3 people who want to buy my share would be willing to pay more than £1 in order to secure the purchase of the share. Say in this example, someone is willing to pay £1.05 and I am willing to sell. This would lead to an increase in the share price.
Share price decrease
If there is low demand, there may be 3 shareholders who want to sell their Netflix share and only 1 person who wants to buy a Netflix share. In this example, it is likely that one of the shareholders may accept less than £1 in order to secure the sale of their share. Say in this example they are willing to sell for 95p. This would lead to a decrease in the share price.
These are very simplified examples of how the price of a share changes but should give an indication of the mechanisms that drive share price.
How to Invest in Equities
The last few years have seen a number of free-to-use trading platforms appear, meaning that anyone can invest in their favourite companies through an app.
Trading 212 and Freetrade both allow users to purchase a wide range of stocks with no fees.
To receive a free share from Trading 212 when signing up, use this link.
As mentioned in previous posts, a key factor in being successful with investing, and mitigating risk, is to have a diversified portfolio of assets. This means having a portfolio with different asset classes and different equities.
Next up, I’ll be taking a look at commodities.
When investing, your capital is at risk.