How does the stock market work?

Chris Torney / 16 October 2015

How do shares work? What are dividends? Find out what the stock market is all about and the different types of investment options.

If you want to get higher returns on your savings than deposit accounts or cash ISAs can offer, you could consider investing in the stock market.

Putting money into shares (also known as equities) generally gives you a better chance of getting a higher rate of return. But these returns are never guaranteed (as they are with bank and building society savings), and they carry the risk that some, or even all, of your original capital can be lost.

Read Annie Shaw's guide to investment mistakes.

How the stock market works

As companies grow, they can raise extra money by issuing shares. The cash they receive from selling the shares is used to expand their operations, while the shareholders are given ownership of a proportion of the company in return.

When the company makes profits, each shareholder receives a share of those profits in the form of dividends – although it is up to the company’s directors how much of the profits are shared out in this way.

As well as the dividends, the value of each share can increase as the company’s prospects brighten – for example if a pharmaceutical firm were to discover a cure for cancer. Shareholders can profit further by selling shares which have increased in value.

The largest companies in the UK have shares which are traded on the London Stock Exchange, and anyone can buy these shares at their market price.

On the downside, however, if you own shares in a company which goes out of business, you are likely to lose all of your money.

Is the stock market not for you? Find out more about investing in ISAs.

Your investment options

If you want to put money into the stock market, you have a few options.

You can buy and sell shares in individual firms through a stockbroker – there are a number of online-only brokers and share-dealing services which charge only a few pounds per trade.

Alternatively, you can invest in a stock-market fund which is run by an expert fund manager, and which can hold shares in a wide range of companies, in the UK as well as overseas.

Funds which hold many shares can help reduce the amount of risk you face, so your investments are less likely to fall or rise sharply in value.

Generally speaking, stock market investing is for people who are happy to put their money away for at least five or 10 years – this gives them the chance to ride out any early losses.

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.