Companies divide their capital into units called shares. When you buy a share, you gain part ownership of that company. As a part owner you will normally be allowed a right to vote in certain circumstances on the running of the company, including in the appointment of directors who will manage the business of the company, and a right to a dividend paid from profits if the directors decide to pay one. Investors hope to benefit from rising share prices and income streams over time (i.e. payment out of a company’s profit in the form of a dividend), and can sell their shares when they choose.
If you are thinking of investing in shares, bear in mind that they do carry more risk than most other investments; this is because you rely entirely on the performance of a single company. This can offer the potential for higher returns if the company performs well, but equally you could lose your entire investment in extreme cases.
When economic conditions are positive, markets are likely to be stable and therefore companies more likely to perform well. This makes investors more confident, and can make the demand for shares rise and share prices increase.
If economic conditions are difficult, markets are likely to be unstable and therefore companies profits may suffer as a result of tough market conditions. This will make investors nervous, and demand for shares may slow and so share prices could fall.
Shares should generally be held in a portfolio where there are investments in a range of companies across different industries and even sometimes countries to provide diversification or balance.
When you buy a gilt or bond you lend money to the issuer for a fixed period, in return for a fixed rate of interest. ‘Gilts’ are bonds issued by the UK Government while most other bonds are issued by companies. Gilts are generally considered the safest type of bond, because it is considered unlikely that the Government will default on a debt.
The end date of a bond is called its maturity date. If you still own the bond when it matures, you get back the issue price (usually £100 per bond) which would be what you paid for it if you bought it when it was first issued. The market value of gilts and bonds will change between their issue and their maturity and they can be influenced by various factors such as interest rates, inflation and exchange rates.
When interest rates go up, bond prices go down. For example, if your bond pays 6% interest and interest rates rise from 4% to 8% your bond would become less attractive as the rate of interest it is paying is less (by a half) than the interest rate you could get by putting your money in a bank account. The opposite is also true: falling rates tend to cause rising bond prices. Rising inflation is bad news for bond prices, as the income generated by a bond is a fixed amount of money, meaning bond’s buying power will decrease if inflation rises. Foreign exchange rates can also have an influence, particularly if the pound is struggling against other currencies, which may force the Bank of England to increase interest rates.
Corporate bonds or gilts can help reduce your overall portfolio risk as, compared to shares, they tend to carry a lower level of risk, though this is not always the case; some bonds are riskier than some shares. The prices of bonds tend to move more predictably – and less suddenly – than those of company shares. This means while you’re less likely to make a quick profit, with some bonds there is normally less chance that you will lose your money altogether.
Investing in a fund is different from investing directly in shares or bonds. You can find out more about funds in our Understanding Funds section.