Your coffee break investment plan - Day 2: What is the stock market?
These are traded back and forth by people and computer programs every day, based on their perceived value either at that moment in time or on a future date. Share prices change all the time.
The stock market is simply the place where this happens – nowadays mostly electronically through exchanges, the first of which was the Amsterdam Stock Exchange, established in 1602. Of course, in those days, share prices were written down on paper rather than displayed your screen.
When people say, “the stock market rose yesterday”, they are taking all the companies listed under a certain umbrella as a whole. The FTSE 100 index, for example, is a list of the top 100 companies in the UK. Its performance is a statement on how well they are doing and, by extension, the UK’s economy.
Shares exist to raise capital. If a company needs money for whatever reason, such as expansion into a new territory, it can sell shares. A company can issue new shares at any time – and while it’s easy to imagine this being bad for existing shareholders (known as share dilution) it can also signal good times ahead for the company and work in everyone’s favour.
Why does the stock market go up and down?
The prices of shares change constantly. For a recent example, take the case of oil prices falling so dramatically. This caused many people to believe that big oil companies BP and Shell would make smaller profits in future, thus lowering the value of their stocks, and so they sold their shares.
Factors that affect the perceived value of stocks and shares include:
- political stability in certain regions
- the weather
- proposed government investment (look at the argument over building on the green belt that’s currently brewing)
- market sentiment (the trust people have in the economy/banks/private companies).
- With so many factors at play, it’s a wonder that anybody can navigate the stock market at all. But there are simple ways to invest that mean you don’t have to worry too much about the ups and downs.
What returns can I expect?
If you invest in the stock market for a year, you might do well, badly or break even. So don’t invest if you only have a short time period before you need your money.
You need to be able to put your money away for at least for 5-7 years, because history shows us that this is the period over which you can at least expect to break even and in most circumstances are likely to get a decent return.
However, if you’re prepared to wait, making sure to continue investing gradually, re-investing any returns you make over and over again, the rewards are bigger.
The Barclays Equity-Gilt study is a highly regarded annual survey that sheds light on where the best investment returns can be found. The study shows that since 1899, UK shares have produced an average annual return of 5.1 per cent over inflation. That compares with 0.8 per cent above inflation for cash.
Barclays concludes that shares typically deliver higher returns - and over longer periods they likely to perform better than other asset classes. In other words the "risk" of holding these shares reduces the longer you hold them.
AXA Self Investor assessed the 10-year performance of the FTSE 100 – an index of the 100 largest companies on the London Stock Exchange - on a rolling monthly basis since February 1996. During this period, it found that the index generated a positive return 9.5 times out of 10, turning £1,000 on average into £1,690 over the 10 years (this is total return - including income from dividends).
The research found only six out of 120 occasions where investors would have lost money over a 10-year period. You would have lost money only if you had bought during the dot com bubble in the late 1990s and subsequently sold at the lowest point of the financial crisis 10 years later. For more on this read Why you should lock investments away for 10 years.
Will I lose my money?
If you try to outsmart the market and handpick shares and buy and sell at the right time? Yes, most probably – unless you’re very lucky.
However, invest sensibly, steadily and regularly into the stock market using a fund that replicated performance of the FTSE 100 index over at least a decade and it would take an extreme dose of bad luck to not make substantially more than you would through your average cash individual savings account (Isa).
You just have to remember to hold your nerve and stay invested when the economy gets shaky and people panic, the occurrence of which comes and goes like the seasons.
If you missed it, make sure you read the first article in this series.
Here's the link to the next one:
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.