What is a stock market?
A stock market is basically a collection of exchanges (you might have heard of the New York Stock Exchange, it’s probably the most high-profile stock market in the world). It works like an auction house – shares and other investments are bought and sold, pairing up thousands of buyers and sellers to make trades with each other.
Prices are determined by supply and demand. So if more people want to sell a particular investment than buy it, it’s likely that the price is driven down as sellers accept lower and lower prices. On the other hand, if everyone wants to get their hands on an investment, the price will increase as buyers offer more money.
Demand can be influenced by anything from a company’s financial reports, to big political events, to Kylie Jenner tweeting that she never used Snapchat anymore, which sent the Snapchat stock plummeting US$1.3 billion. How does it go…? ‘Sticks and stones may break your bones but Kylie Jenner’s words will ravage a stock…’
In the past, most stock markets were physical market places – you can probably imagine a room full of men in suits shouting over each other. Nowadays they’re electronic, making them faster, more reliable and much more efficient (and quieter!). Buyers and sellers are matched up from all over the world to trade billions of pounds of investments every day.
The UK’s biggest stock market is the London Stock Exchange (LSE) based in the City of London (shocker). Other stock markets you might have heard of are the Nasdaq or Dow Jones in the US and the Hang Seng in Hong Kong.
Different types of investments
You can invest in all sorts of different investments and they’re sometimes referred to as asset classes. Here are some of the most mainstream options.
Cash – the ‘safe haven’
Cash is considered ‘safe’ because it’s unlikely that you’ll lose savings in the same way you might if you choose investments that go down in value. Nevertheless, cash isn’t risk-free either. Over time the silent assassins of cash accounts, low interest rates and inflation, can eat away at the buying power of cash aka how much you can buy with your money (in case you forgot).
Shares – the something for everyone one
There’s a good chance you’ve heard of shares before. Companies are owned by shareholders, so having shares means you are part-owner (easy tiger) of the companies you choose to invest in. This means that you could get a share of any company earnings or income (known as ‘dividends’), as well as any increase in the company’s value.
Bonds – the IOU one
Governments and companies can use bonds to raise money, maybe to maintain the business, fund a new project or replace the fridges in the kitchen (not really). This is usually known as issuing a bond. It’s a bit like when you were a kid and you borrowed a fiver out of your sibling’s money box and left an IOU. The difference between these bonds and the IOU you left as a kid is that they can be traded on the markets and people can buy them as investments.
The most common type of bond has a fixed term – how long the bond, or ‘loan’, will last before it needs repaying. The end of this term is known as the maturity date and this is when the original loan is repaid (known as the par value).
The key difference between buying a share and buying a bond is that a bond is only a loan, and you generally do not have any ownership in the company or entitlement to its profits.
A bond holder, the person who loans out the money, receives a coupon for lending their cash. A coupon is just the amount of money the issuer will give the bond holder for loaning them the money, and is a little like the interest paid in bank account. The coupon is usually a fixed sum so a bond holder knows exactly what they will receive in payments and when.
Property – bricks and mortar (literally)
You can buy private or commercial property, often referred to as ‘bricks and mortar’, as an investment and receive income through rent, as well as potential profit if you sell it which is often known as the capital gain (or loss).
You can also buy property shares, which offer you a stake in a property usually owned by a company, or property funds which hold a portfolio of different, underlying property investments (underlying investments are the ones that are within the fund – so they’re not as secretive as they sound).
Some people find it much easier to buy shares (or units) in a property company or fund. It’s not only easier than dealing with the long process of buying and selling a property, it also gives you greater diversification (spreading out your investments) as you own a little bit of lots of properties, rather than taking a chance owning 100% of one property. Buying property shares/units can also make it easier to access money if you need it in a hurry, as it’s generally a lot quicker to sell a share or unit than it is to sell a property.
Commodities – get the goods
Products such as oil, coffee and gold are known as commodities, forming the skeleton of other goods, products or services. The price you can buy or sell these goods for – aka their investment value – is affected by supply and demand, as well as factors like currency rates. It can even be affected by the weather!
Hedge funds – hedging your bets
Also known as targeted absolute return funds, hedge funds can potentially make money in all market conditions – but this isn’t guaranteed (as usual, eh?). Some of the ways they try to make money can be complicated so anyone investing in them should take the time to get their head round them properly. As examples, they can take ‘short positions’ (when managers expect to make money from falling share prices) or take ‘long positions’ (basically the opposite – managers aim to make money in shares they expect to rise in value).
A bit on funds
Funds are another way to buy shares (or other investments). We like funds at Bestinvest because they’re a much easier way to invest than choosing individual shares or other investments. Plus they help you have a good spread of investments, which is important.
Instead of buying one piece of a company that you can trade, you give your money to a fund manager who puts it with money from other investors, or ‘pools it’. The manager will then invest the money, buying a number of shares in different companies.
There are thousands of funds out there and all of them vary in size, where they are in the world, approach and aims. Not all invest in shares either, some invest in things such as bonds and other investments.
Active V Passive funds
It’s widely debated in the investment world whether active funds or passive funds make more money for investors. It’s not our place to answer this for you, but here’s some info on both so you can see what you think.
Active funds are run by fund managers. They research and pick investments that they believe will do better than the market – the fact someone watches them like a hawk and makes changes to your fund to try and improve things when necessary means the fees are slightly higher.
Passive funds aim to perform the same as the stock market. In turn, they have lower fees, but nothing will be done to try and protect your money if the stock market goes haywire, and your investments will never do better than the market – but an active fund might.
Exchange-traded funds, widely known as ETFs, are common passive funds and you can buy them on the stock market like shares. But nota bene, ETFs can be high risk and complex, so you need to make sure you understand all the risks before investing. Like hats, they don’t suit everyone.
