How to invest in the stock market

Savers know it’s important to make their money work hard. Investing money in the stock market offers opportunity for improved returns that are likely to exceed any interest rate a high street bank can offer. Historically speaking, stock market gains far outweigh cash.

Here are five things you need to know about stock market investing.

1. Be comfortable with risk before investing

If you are to give your money the chance of higher returns – than cash accounts – then make sure you are happy with the level of risk.

Stock market investments can be a bit of a rollercoaster which is fine, unless that is out of line with your expectations.

Ideally you should think about what you can afford to lose. Before investing, think about how you would cope if your investments fell by 10%, 30% or 50%, then you can set a limit for yourself.

And as a rule of thumb, you should only invest money that you are happy to have tied up for at least five years – the potential for ups and downs mean the stock market is not the ideal place to save for next year’s holiday.

2. Pick your investments wisely

You may want to seek advice when it comes to choosing where to place your money if you do not have the time to regularly research and manage investments – or the confidence to navigate the market.

Using a fund supermarket you can put in place a series of investments without the help, or cost, of an adviser. Fund supermarkets, also known as investment platforms, allow you to buy, sell and manage shares and funds from companies and many different providers. You can also use a share dealing service.

3. Choose the right time to invest

A much-favoured trick by experts is drip-feeding your money into the market, which removes the need to get the timing right.

By saving a monthly amount into your investment portfolio you can cash in regardless of how the market is performing.

It smooths out the highs and lows in share prices. When they go up, the value of your stocks rise, and when they go down your next contribution buys more. This is known as “pound-cost averaging”.

Plus, buying stocks at a lower price means you get a higher return when the market swings back up.

4. Spread the investment risk

The “asset allocation” or in other words, how you divide your money between shares, cash, bonds fixed interest securities or property, is crucial.

A common mistake investors make is not diversifying enough: as a result, some have been burnt by having all their eggs in one basket – in other words, all their money in one asset class. The idea of diversification is that if one investment has a bad time you should always have others that will not be suffering, so they can act as a counter-balance.

5. Investing in stocks or shares

Being a shareholder is a popular pastime and if you are lucky you could make a substantial gain - but you could equally make losses. This route is riskier than buying a fund which spreads the risk by investing in lots of different companies.

A fund will invest in lots of different companies so if one fails, you don’t lose out to such a large degree.

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 typically 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.

And here's a top tip for savers

Keep your money away from the taxman to enhance returns – that way you can keep every penny of the gains. Who wants to give away any more of their hard earned cash than necessary to HM Revenue & Customs?

Savers can shelter a mixture of cash and stocks and shares up to £20,000 in an ISA (in the 2019-20 financial year), which does not need to be declared on a tax return. This means that interest paid on cash and profits made on investments are free from income tax and capital gains tax, respectively, in perpetuity.

Watch out for scams

Criminals and con men frequently set up dodgy investment firms to persuade people to part with their money.

In some cases, this will be to invest in unsuitable, high-risk ventures – for example, overseas land purchases – while in the worst cases, the fraudsters will simply take your money and disappear.

Beware of being contacted with an “investment opportunity” out of the blue, and be particularly cautious if you feel someone is putting pressure on you to make a quick decision.

If you are suspicious or just unsure about how an investment works, either seek advice or walk away.

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