Want to invest in stocks? A guide to making money from shares

Thinking about investing in the stock market but unsure where to start? You're not alone. We often hear about company shares doing well on the stock market – with headlines like “Apple shares surge” or “Rolls-Royce shares hit record high”.

But if you want a slice of the action, how do you go about buying shares yourself? This guide is designed to walk you through the process of buying shares – also known as investing in stocks – including how to choose them, the pros and cons, and the mistakes to avoid.

What’s on this page?

• What are shares?
• How to buy shares
• Tips on choosing shares
• Common mistakes when buying shares
• Pros and cons of investing in stocks
• How to achieve diversification
• Key takeaways

What are shares?

A share represents a small part of a company. So, when you buy shares, you're basically buying a financial stake in that business. This means you become entitled to a portion of the company's profits (if dividends are paid) and any increase in the share value. But as a small investor, your influence on the company’s decisions is generally limited. Buying shares, also known as investing in stocks, can be a way to make a positive return on your cash.

You might enjoy the process too – especially if you see them rally or get paid a handsome dividend. But investing in stocks is risky. Share prices can fall, and you could lose your money. Shares are traded on stock exchanges, such as the London Stock Exchange or the New York Stock Exchange. The value of shares can rise and fall depending on the company's performance and wider economic conditions.

There are two ways for investors to make money from shares. Firstly, some shares will pay a dividend to shareholders – a fraction of the company’s profits, which is shared out amongst investors. For example, if a company declares a dividend of 5p per share and you own 100 shares, you would receive £5 in dividend income.

The second way is to sell shares for a higher price than you bought them for. Let’s say you bought some shares for £1.50 each – if you then sold them for £2, you would make a profit of 50p per share.

Of course, share prices don’t always go up. If the share price had fallen to £1 and you decided to sell (either because you needed the money or you were worried about prices falling further) you would incur a loss of 50p per share.

How to buy shares

Most people buy shares online using an investment platform as it’s much easier and more convenient than buying paper shares. You’ll easily be able to monitor how your investments are performing and may also get access to helpful tools and research – either by logging onto your account online or using an app on your phone.

It’s important to choose wisely and consider your needs. Some may offer shares just from the UK and maybe a handful from the US, while others have a range of thousands of shares from all over the world.

Charges will vary too. In addition to a platform fee (which is an ongoing fee), you’ll likely need to pay a transaction fee of between £4 and £12 per trade. However, many services will offer free regular investing, so long as you don’t mind committing to buying shares on the same day every month. You may also be able to access cheaper share-dealing charges if you trade more frequently.

Irrespective of the platform you choose, you’ll also have to pay stamp duty of 0.5%. If you buy shares through using a stocks and shares ISA or a self-invested personal pension (SIPP), any growth and dividends will be tax-free. However, you will still have to pay the stamp duty. Alternatively, if you hold shares in a general investment or trading account, you may have to pay tax on dividends as well as capital gains tax when you come to sell.

Tips on choosing shares 

The number one tip is to do your homework. Keith Bowman, equity analyst at Interactive Investor, says: “Take your time and do your research. Like buying a car or an expensive home appliance, time taken to do your homework can prove time well spent in the long run. Consider your own knowledge. Have you worked in a particular industry for years, which might prove a good starting point to select a company?”

It can be helpful to choose companies you understand. Maybe you’re familiar with Tesco or Marks & Spencer because you’ve shopped there for years.

But Sam North, market analyst at eToro, says you should always check their financial health first: “Are they making money, or drowning in debt? A quick peek at their annual reports can tell you a lot,” he notes. Stock market-listed companies usually have an ‘investor centre’ section on their website, containing their annual reports, presentations and trading updates.

Look for ‘Annual Reports’ or ‘Financial Results’. Pay attention to the revenue and profit figures; ideally you want companies to have grown both of these over the past few years. As well as researching individual companies, be aware of market conditions and trends.

North adds: “As new technologies emerge in fields from renewable energy to healthcare, ask yourself which ones are long-term trends that are worth investing in and which are just short-lived fads.”

Common mistakes when buying shares

An easy mistake is to get emotionally attached to your shares. Rob Morgan, chief investment analyst at Charles Stanley, says liking a company’s product or service is not sufficient reason to buy a stock.

“Successful share investing will likely involve much more: research on earnings, the state of the balance sheet, competitive position, expansion plans and so on.” If you do invest, emotional attachment could also make you miss the signals to sell the share.

So you’ll need to try and keep a cool head, and take your time to work out what to buy, and when to sell. According to North, another mistake is “chasing hot tips from your mate Dave down the pub; he’s not Warren Buffett”.

Bowman echoes this: “Do your own research. Don’t just follow a share tip.” North adds that timing the market is usually a recipe for disaster. “People often buy high in a frenzy – like the GameStop mania [a sudden surge in GameStop shares driven by hype on internet forums, which led to many investors losing large amounts of money] and sell low in a panic.”

This means you invest when the share price is expensive, and end up selling at a loss. If you want to buy more shares, consider setting up a direct debit so you invest more each month. It takes the emotion out of your decisions, and you won’t be tempted to try timing the market.

Pros and cons of investing in stocks

Investing in shares can be a great way to build your wealth. Over longer time periods, shares typically beat cash held in savings accounts, according to a study by Barclays going back to 1899.

North comments: “Buying shares wisely can help you ensure financial security in retirement, combat inflation, and maintain your desired lifestyle.” You do need to be able to stomach some risk though, and invest for at least five years (ideally 10 years) to help ride out any ups and downs in the stock market.

Morgan points out that for people who have the time, aptitude and enthusiasm, buying shares in a company “can be exceptionally rewarding, both intellectually and financially”. However, he adds: “Be under no illusion, it will be hard work if you want to do it properly and create a diverse portfolio that works well. Not everyone wants to spend their spare time scouring company accounts, following industry developments, and assessing key metrics!”

Pros

• Shares usually outperform cash in the bank over 10-year periods 
• Some shares pay dividends, which gives you an extra income stream
• You can invest in companies you’re interested in and passionate about 
• You may get voting rights so you can influence company decisions (although for small investors, this is mainly symbolic, since it’s unlikely that your vote will significantly affect decisions)
• Shares in developed markets like the UK and US can be bought and sold fairly easily 

Cons

• Shares are more volatile than cash, so you’ll need to be prepared for them to go up and down 
• Shares can fall in value, and you could lose your money 
• Picking winning stocks can be difficult because the future is uncertain  
• Buying just one stock is risky. So you need to choose and monitor a range of shares to ensure diversification, and this is time-consuming 

How to achieve diversification

It’s important that you diversify when you buy shares. North says: “If you only invest in one stock and that goes down, so does your whole portfolio, so it’s best to invest in a range to spread the risk. Make sure you are not overinvested in any single company, industry or geography.”

Building a portfolio of shares requires a lot of time. You’ll need to keep on top of company announcements and how the share price is performing. This means that unless there are specific companies you want to invest in, buying a fund can be a more sensible option, especially if you’re new to investing.

Morgan says: “Funds spread your investment – and risk – across dozens of different companies and are either managed by a professional fund manager (in the case of ‘active’ funds) or designed to simply track a particular index (in the case of ‘passive’ funds or ‘trackers’).”He adds: “While it can be a challenge to devote enough time  to monitoring a portfolio of individual shares, it’s a lot easier to keep tabs on a few funds.”

Of course, you may like to do a bit of both, and that’s fine too. According to Morgan, some people invest in stocks by establishing a central portfolio of funds, with some specific shares on the side “for more involvement and fun”.

Feeling keen to get started? Your next steps could be to: explore investment platforms, research a few companies you're interested in, and consider opening a stocks and shares ISA.

Key takeways

• Shares are individual units in a company available to buy 
• You can make money from dividend income and by selling shares at a profit 
• It’s essential to thoroughly research the growth potential of shares before you buy – don’t buy a share on the back of a tip  
• Investing in stock of a single company is high risk. Your investments are more likely to be successful if they are well diversified 
• Buying funds, instead of individual shares, provides a lower risk way of investing in the stock market as you will be spreading your money across a wider range of businesses