Investing directly in shares
By Michael Trudeau
Investing directly in shares
Get the lowdown on investing in shares, from the different types available to the returns you can expect.
One of the most traditional ways to invest your money is to buy shares in individual companies.
They form the asset class known as 'equities' and, historically, they have outperformed safer investments such as cash deposits and government and corporate bonds. Over the long term, shares can act as the real driver for growth in your investment portfolio.
However, with this potential reward comes greater risk. Investment in shares exposes you to the potential to lose some, or all, of your money.
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What are shares?
Shares are issued by companies as a means of raising money. Essentially, companies are selling part of their business to investors, and shares offer people outside the company the opportunity to receive profits if the company is successful.
As a shareholder, you become a part-owner of the company, which gives you certain voting rights and additional benefits beyond the receipt of your share of the profits. However, private investors have relatively little say in how the company is run. In reality, institutional shareholders such as pension funds and other collective investment funds hold large numbers of shares and usually carry the day when it comes to shareholder votes.
Different types of shares
There are two types of company shares you can buy:
Buying ordinary shares makes you a part-owner of the company. If a company has met all its other obligations and decides to distribute some of those profits to shareholders, you'll be entitled to get the lion’s share of the companies’ profits . Most ordinary shares are voting shares, meaning you get a say on matters relating to the company, such as director’s fees or whether to agree to a takeover.
The risk with ordinary shares is that you have no guarantee that you will receive any share of the profits (see below for further explanation) and, if the company goes bust, you’re the last in line to be repaid your investment.
These shares carry no voting rights but, as the name suggests, entitle you to other rights. Preference shareholders usually get a share of the profits before ordinary shareholders, usually as a limited amount defined by the issuing company.
In addition to this, preference shareholders – although near the end of the line for any payout – do get any money paid out before the ordinary shareholders if the company goes bust. Preference shares are generally seen as less risky and, therefore, payouts are generally lower than for ordinary shares.
Find out more: The beginner's guide to investment - we cover everything you need to know to get started in the stock market
What kind of returns can you get from shares?
The return from shares comes in two forms: dividends and capital growth.
Dividend payments are the distribution of the profits that the company has made, usually paid out twice a year.
You’re more likely to receive dividends from larger, long-established companies – the more profitable the company is, the larger the dividend payout could be.
Smaller companies are less likely to pay out a dividend, as they reinvest their profits to grow their business. However, if a smaller company does manage to successfully expand, the value of your shares could expand (see below) and provide opportunity for dividends at a later date.
You can make a profit if you sell your shares for a higher price than what you bought them for. This provides you with capital (the money you invested to begin with) growth.
The price of your shares is affected by both internal and external factors.
Companies publish their financial results every six months, as well as trading updates and announcements of dividend distributions for the future. If the company is performing well and is expected to do so in the future, this should have a positive effect on the share price. Conversely, if the prospects aren’t looking good, the share price can fall.
The wider economy is also influential on the share prices. If economic conditions are good and investors have confidence in companies’ ability to grow, the demand for shares increases. This market sentiment and investor demand for shares can increase the price. If demand outweighs supply, share prices will go up.
Of course, if the economic climate is not good, investors may not be so confident in a company's prospects. Therefore, the share price can fall, even if the company is performing well.
Tax on shares
You will be taxed on any returns you make as a shareholder, either through dividends or when you decide to cash in on capital growth. Find out more by reading our guide to tax on your savings and investments.
One popular way to invest in shares tax-efficiently is to buy within a stocks and shares Isa, where you can avoid paying 7.5% tax on anything that goes beyond your £5,000 tax-free dividend allowance. Keep in mind that companies pay corporation tax on their profits so, in a way, the dividends you receive have already been taxed. Capital gains are tax-free within an Isa.
To make it simple for potential investors in shares to find sellers, many companies opt to have their shares listed on a stock exchange, for example the London Stock Exchange (LSE). This ensures that there is ready-made market to trade shares.
Smaller companies are often unlisted, but hundreds are traded on the Alternative Investment Market (AIM). These companies are generally seen to be more risky investments than those companies listed on the main market.
How to buy shares
Traditionally, people bought shares through specialist stockbrokers, but now DIY investors usually go through a broker such as a fund supermarket. Most of these brokers brand themselves as one-stop shops for investing, and offer full stockbroking services alongside their fund options.
Read our review pages for leading providers to help you find the right fund supermarket. Our reviews explain how the different companies charge, and reveal our unique customer satisfaction ratings, in which more than a thousand Which? members have rated fund supermarkets for customer satisfaction and other aspects of this service.
- Last updated: February 2016
- Updated by: Michael Trudeau