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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 70% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

Why invest in shares? The advantages and risks of stock investing

With the increasing cost of living, a second income is often needed to keep afloat. Some people may consider investing in company stocks to earn an extra income. However, investing comes with its advantages and risks. Discover if stock investing is worthwhile.

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Call 0800 409 6789 or email if you have any questions about trading or investing. We're available 24/7 between 8am Saturday and 10pm Friday.

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Is investing in stocks worthwhile?

Whether or not investing in stocks is worthwhile depends on your aim and alternatives that are available to you. If you are willing to take on risk, then investing in shares is a way to profit from stock prices going up and dividend payments.

However, remember that you could lose money and that past performance doesn't guarantee future returns.
There are two ways to earn a return on investment from the company shares you own:

  1. Share price appreciation
  2. Income from dividends

1. Share price appreciation

Share price appreciation occurs when you buy stocks and sell them at a higher price. The greater the difference between the buy and sell price of your stock, the higher your return on investment.

For example, investing in an index like the S&P 500, which contains 500 large US companies and aggregates their individual performances into a single index. Historical financial market data shows that the S&P 500 appreciated over a 25-year period and peaked at 370% return.

Graphic showing the increase of an investment into the S&P 500 over a 20-year period from 2000 to 2020.

Note that buying shares in an index like the S&P 500 often yields better returns as compared to individual company stocks since each carries its own risk.

Graphic showing the share price performance of the Tesla stock over a 5-year period from 2019 to 2023.

2. Income from dividends

Dividends are periodic payments a company makes to shareholders from its revenue. Not all companies make dividend payments, meaning you’ll only earn these if the company you’ve invested in pays them.

Stocks that are known to pay regular and stable dividends are known as ‘dividend stocks’ or ‘income stocks’. Dividends can be paid into your account for withdrawal or used to buy more shares. Note that dividends from common stock and preferred stock are treated differently.

Earning a dividend income can make a huge difference to your returns over time. You can build long term wealth by reinvesting your cash divided using the compounding effect, yielding more returns from that lump sum. Compounding is exponential, meaning even though the initial amount might be small in the short term, the value of your investment portfolio will grow significantly in the long term.

For instance, if you’d invested £10,000 invested in the FTSE 100 at the beginning of 1986 and automatically reinvested any dividends you received, your investment would have grown to £195,852 due to compounding.

Graphic showing the different types of income shareholders have, which are company profits and dividends paid per share owned.

Potential advantages to buying stock

The potential advantages of buying stock is earning an income, mostly through passive investing. The returns form the stock market also tend to occur at a faster pace than the inflation rate.

The large number of buyers and sellers available on the stock exchange make stocks more liquid, making them faster to sell compared to real estate which are non-liquid assets that take longer to convert into cash. That being said, buying stock does carry risk too, which we explore later.

Here are some advantages that come with buying shares:

  • Higher returns than cash investment. Cash investments are low risk, but returns are low, too. Shares are riskier, but the potential rewards can far exceed interest earned on savings
  • Share price appreciation. Companies are productive assets in the business of earning revenue. If revenue (current or projected future earnings) increases, a share of ownership in the company becomes more valuable, too
  • Dividends. You’ll be eligible to receive dividend payout on your investment earnings, provided the stock you’ve invested in pays these
  • Protection against inflation. Although share prices often drop when inflation first hits, they adjust their value after a while, thereby protecting wealth against the corrosive effects of a rise in prices
  • Diversification. This mitigates risk, as you can get exposure to many different markets. Especially through an ETF
  • Liquidity. Stocks, unlike property or physical assets, can generally be sold quickly at the going market price. Property is often used as investment since they appreciate in value over time
  • Small and discretionary outlays. Unlike property, you’re not required to pay a large outlay all at once, meaning you can invest small amounts at your discretion. With property and mortgages, you’re expected to pay the full value of the investment upfront
  • Tax benefits. You’ll get tax benefits when investing in individual savings accounts (ISAs) and self-invested personal pensions (SIPPs)

ISAs and SIPPs

ISA accounts is tax-free up to £20,000, enabling you to have a considerable tax break, serving as an incentive for you to save. These accounts are zero tax, helping to protect your savings and investments from capital gains, including taxation on dividends and interests you earn through them.1

SIPPs are a form of pension that enables you to have increased variety and flexibility on how your nest egg is invested right up to the start of your retirement and beyond. It's tax-free until you start withdrawing it, then you'll be taxed based on the amount and type of income you receive.

Also, it's flexible because you choose how to invest in thousands of shares or funds with us whereas some pensions have limited choice of investments. Open an ISA or SIPP account with us.

Risk vs reward

The reason the above advantages are possible is because you assume risk when investing. Risk is the chance that you may lose some or all of your investment amount, which is a factor of uncertainty.

The more uncertain the outcome of an investment, the greater the potential reward you should be offered. How you decide to navigate risk depends on your individual preferences, or ‘risk appetite’.

A graphic showing a risk versus return curve for the cash, fixed income and equities asset classes

Evaluating your appetite for risk

There are several things to consider when analysing your risk appetite. The top three are your investment aims and horizon as well as risk profile.

Investment aims

When investing, you need to ask yourself what the aim behind it means for you. Ask yourself the following fundamental questions that’ll help you to establish the investment approach that’s most suitable to you: why am I investing? Am I looking to gradually grow a capital amount? Or am I looking to take on increased risk with the expectations of earning high returns?

Investment horizon

If you intend to invest for a long period such as over a 10-year time horizon, you can assume more risk as you’re less exposed to the day-to-day share price volatility. If your investment horizon is shorter, you’d probably want lower risk stock since you’d be more exposed to price fluctuations.

Risk profile

If you want to maximise returns for a given level of uncertainty, you’d have a risk-averse profile. But if you’re looking for high rates of returns regardless of uncertainty, it would mean you’re risk neutral. However, if you have a risk-seeking profile, it would mean you’re actively searching for risk because of its potential upsides.

Risks when buying stocks

There are risks involved when buying stocks. That’s because all investment activities carry a certain level of uncertainty, and this is something you must give careful consideration prior to committing capital. Ensure that you make use of our risk management tools. These are some of the risks you’d need to consider:

  • Investment risk is the level of uncertainty inherent in all types of investing. Often, the higher the return, the higher that risk. The type of investment risk you take depends on your risk profile
  • Company risk is the level of exposure the stock you’ve invested in has due to circumstances that negatively impact profits, potentially leading to its failure
  • Market risk is related to losses you might incur due to the entire market being affected by unfavourable price movements
  • Share price volatility provides a measure of the overall value at which the stock market fluctuates up and down. These are at times unpredictable sharp price movements
  • Exchange rate risk is when the change in currency exchange rates impacts the operations and profits of the company you’ve invested in
  • Liquidity risk is when a company doesn’t have sufficient assets to be converted into cash so as to meet its financial obligations and timeously settling debts without impacting its share price

Common vs preferred stock

Common and preferred stock have different features. Which stock you buy depends on your aims.

  • Common stocks enable shareholders to have voting rights at stockholder meetings and to receive dividend payments, provided the company pays them
  • Preferred stocks are issued to shareholders as priority recipients of dividends. They usually don’t come with voting rights, but stockholders are likely to be able to claim earnings than common shareholders

If you’re investing in stocks seeking to earn an income or dividends, then you could consider preferred stocks. Here’s why:

As a preferred stockholder, your expected revenue stream tends to be more dependable since your dividend payout is a fixed amount and it’s prioritised above that of common shareholders. The income you earn from your shares is likely to be relatively higher compared to common stockholders.

Being a preferred shareholder, you’re privy to a variety of this type of shares such as cumulative and participatory preferred shares, to name a few.

  • Cumulative preferred shares have a clause that protects you when company profits take a hit. These enable unpaid dividends to first be paid out to you as a preferred shareholder before common stockholders
  • Participatory preferred shares refer to when you’re guaranteed additional dividend payouts above the normal fixed dividend rate, provided the company you’ve invested in meets specific financial objectives

Investing in ETFs vs stocks

Exchange traded funds (ETFs) are instruments that track the performance of a group of underlying assets. These can range from stock index ETFs, which track indices like the FTSE 100, to currency or sector ETFs that trail multiple currencies and companies in the same industry, respectively.

ETF shares offer a single-entry point for increased access to a wide variety of markets and assets, which helps to diversify your risk. With us, you can access over 5400 global ETF markets using the UK’s best platform.2

Managed portfolios

Managed portfolios are handled on your behalf. With our Smart Portfolios you’d get a diversified basket of assets – from low to high risk – depending on your risk profile, that would be managed by experts, increasing your exposure to the global markets. These would include fixed income and equity as well as alternative investments like commodities and real estate.

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1 Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.
2 Best trading platform as awarded at the ADVFN International Financial Awards and Professional Trader Awards 2022.
Best trading app as awarded at the ADVFN International Financial Awards 20222.