The most common and widely accepted definition of shares is that they “are units of ownership in a corporation or financial asset” (Investopedia, 2018). This is to say that you can divide a company into equal parts, and each part constitutes a single share.
In modern times, the first company to have its shares traded was the Dutch East India Company, the globe sprawling giant that gave humanity its first glimpse of globalisation. This occurred in 1606 and since then the concept of trading ownership in companies has grown into a multi-trillion dollar industry.
WHERE ARE SHARES TRADED?
Stocks and shares are traded at a central place called the stock exchange. The most important function of stock exchanges is to provide a mechanism for Price Discovery. This is where fund providers and those who need funds meet to allocate funds into financial assets, and this way a price (and the return on these assets) is found. This is known as the supply and demand model.
This is easily explained by looking at the price of any commodity, such as oil. If there is an increase in the amount of oil used by the worlds population, the price will go up. This may happen on the financial markets when expected growth figures are revised upwards. If the opposite happens and world growth figures are revised downwards, then the future demand of oil has decreased from previous estimations, which results in the price of oil also declining.
WHY DO PEOPLE BUY SHARES?
There is usually only one fundamental reason, and that is to make money. There have been numerous studies that have documented that shares are in the top category as one of the best long-term investments in any financial market. Historically shares have outperformed treasury bonds, corporate bonds, property as well as many other asset classes.
The two types of return associated with owning a share are known as annual income and long-term capital growth or appreciation. Let’s break this down, an annual income is when a company returns some of its profits back to the owners (the shareholders). This usually happens quarterly and is known as a dividend, the total dividend for a year is the annual income. Capital growth or capital appreciation is when a particular companies share price raises in value, this can happen due to a variety of factors, from economic conditions to good management. This is how money is made from shares.
Key reasons for owning Shares:
- To beat inflation – with current account savings at an all time low the stock market is one of the few markets left that offer inflation beating returns.
- Low maintenance – it is crucial to monitor your portfolio at regular intervals, but when compared with other types of investment, such as renting property, the amount of on-going effort is less significant.
- Globalised world – in the past share ownership was firmly rooted in investing in well known UK companies, but this is now a thing of the past. Today you can access and purchase shares in over 100 countries as a UK citizen. This opens up new markets and opportunities irrespective of geographical location.
- Limited liability – the financial innovation of separating liability risk from ownership revolutionised the financial system. Today there is no risk of being held personally responsible for a public companies debts, which gives investors confidence in that they understand only the value of the shares can be lost.
- Very good liquidity – Due to the high volume of buyers and sellers in exchanges, it is possible to turn shares into cash within minutes while the financial exchange is open.
Key reasons for avoiding Shares:
- Level of risk – when compared to other safe assets, such as government bonds or cash deposits, the level of risk is an order of magnitude greater. This is compensated by the increased rewards, or profits to shareholders.
- Market volatility – The financial markets move in broad cycles, and crashes are semi-frequent events. This can pose a large risk to those who invest at the wrong time, as it can take decades for a portfolio bought at a peak before a crash to recover.
- Lack of Control – as a small shareholder in a public company, your individual influence on the management or running of the company is going to be non-existent.
- Knowledge – the financial markets are watched and analysed by some of the brightest minds in the country, and so the competition for making a profit is often very high.
- Fraudulent Stock Brokers and Educators – An entire market of fraudulent brokers and educators has emerged. Unsuspecting beginners often fall into the traps set out by brokers who have the “perfect profit making system” or educators that tell you that “its easy to make $10,000 a month trading the live forex markets”.