Shares 101: the beginner's guide to ownership

Understanding what shares represent

Every investor has to start somewhere, and for most, that journey begins with shares. Learning how shares work opens the door to understanding broader financial markets. From foundational concepts and how markets operate to the strategies behind successful investing, getting to grips with shares is the first step.

What shares represent

Shares, or equities, represent units of ownership in a company. When you purchase a share, you're effectively buying a piece of that business. For instance, if a company is valued at £10,000 and has issued 2000 shares, each share would represent £5 of ownership (£10,000/2000 = £5).

This gives you a tangible stake in the company's future. As the business grows in value, your shareholding increases in worth. Often, people are already share investors without realising it, as most pension plans include holdings in public companies.

The concept of share ownership extends beyond simply holding a certificate or digital record. As a shareholder, you gain certain rights, including voting on company matters and receiving annual reports detailing financial performance.

Why companies issue shares to raise capital

Companies issue shares primarily to raise capital. Instead of borrowing from banks, a company can sell a portion of its ownership to investors in exchange for funds. This capital is typically used to expand operations, invest in new product lines, or acquire competitors.

Investors, in turn, expect their capital to be used wisely, generating returns through either share price appreciation or regular dividend payments. This relationship creates a mutual interest between companies and shareholders in achieving long-term success.

The decision to issue shares represents a significant milestone for companies. Going public through an initial public offering (IPO) transforms private enterprises into publicly traded entities, subjecting them to increased scrutiny and regulatory requirements.

However, the benefits often outweigh the challenges, providing access to substantial capital that can fuel growth and expansion strategies previously impossible through traditional financing methods.

How share prices move in financial markets

Share prices are dynamic and influenced by supply and demand. When more investors want to buy a share than sell it, the price rises. Conversely, an excess of sellers drives prices down. Underlying these movements are earnings and sentiment.

Company profits, especially when they exceed market expectations, can push share prices higher. Likewise, investor sentiment — shaped by factors such as industry trends, economic conditions, and confidence in management — plays a critical role in driving market prices.

Economic indicators, geopolitical events, and sector-specific news all contribute to price volatility. Understanding these factors helps investors make more informed decisions about when to buy or sell shares.

Market psychology often drives short-term price movements, creating opportunities for astute investors who can distinguish between temporary fluctuations and fundamental changes in company value.

Where and how share trading takes place

Trading takes place on stock exchanges such as the London Stock Exchange (LSE) for UK companies, the New York Stock Exchange (NYSE) for large United States (US) firms, and the National Association of Securities Dealers Automated Quotations (NASDAQ) for technology-focused stocks. Depending on your desired level of involvement, brokers offer various services.

Full-service brokers manage your portfolio, advisory brokers offer recommendations, and execution-only brokers simply carry out your trades. Trading hours are limited to when the exchange is open, which varies by region and season.

Modern technology has revolutionised share trading, with online platforms providing real-time market data and instant execution capabilities. This democratisation of investing has made share ownership accessible to a broader range of investors.

Trading platforms now offer sophisticated tools previously available only to professional traders, including advanced charting capabilities, research reports, and risk management features.

Understanding dividends and income generation

Aside from price gains, shares can also generate income through dividends - cash payments made from a company's profits. Companies that are still growing often reinvest their profits and don't pay dividends, aiming instead for higher share price appreciation.

More mature companies, however, tend to distribute regular dividends, offering a steadier investment return. When private companies go public via an IPO, they allow ordinary investors to buy shares for the first time.

Dividend policy varies significantly between companies and sectors. Technology companies typically reinvest profits into research and development, while utilities and consumer staples often provide consistent dividend payments.

Understanding a company's dividend history and policy helps investors align their investment strategy with their income requirements and risk tolerance preferences.

The power of dividend reinvestment

Now, let's look at how total return - an investor's actual performance when dividends are reinvested - can make a dramatic difference over time. Consider a FTSE 100 stock that pays a 4% annual dividend.

If the share price grows at an average of 3% per year over five years, without reinvesting dividends, the capital gain alone would give a 15.9% return. However, reinvesting those dividends each year compounds the income.

Assuming the dividends are reinvested annually, the total return over five years rises to approximately 34%, not just 15.9%. This demonstrates how reinvesting dividends can nearly double your effective return.

The compounding effect becomes more pronounced over longer periods, turning modest gains into significantly greater long-term wealth through the mathematical power of exponential growth.

Real-world example of share investment returns

Taking a real-world example, let's say you invested £10,000 in a FTSE 100 stock like Unilever in July 2020, with a dividend yield of around 3.5% and annual share price appreciation averaging 2.5%.

Without reinvestment, your investment might grow to around £11,315 after five years. But with dividends reinvested, your investment would be worth approximately £12,100.

This 21% total return versus an 11.3% capital return highlights the importance of considering not just share price movements but also dividend policy when evaluating long-term share performance.

These calculations illustrate why professional investors focus on total return rather than price appreciation alone when assessing investment performance and making portfolio allocation decisions.

Different types of shares and markets

Beyond ordinary shares, investors can choose from various equity instruments including preference shares, which typically offer higher dividends but limited voting rights. Exchange-traded funds (ETFs) provide exposure to diversified portfolios of shares through a single investment.

Growth shares focus on capital appreciation, while value shares trade below their perceived intrinsic value. Income shares prioritise dividend payments over growth, appealing to investors seeking regular cash flow from their investments.

International markets offer additional opportunities, though they introduce currency risk and regulatory differences. Emerging markets potentially provide higher returns but with increased volatility and political risk.

Sector-specific considerations also matter, with defensive sectors like utilities performing differently from cyclical sectors like construction during various economic conditions.

Risk management and portfolio diversification

Successful share investing requires understanding and managing risk. Diversification across different companies, sectors, and geographical regions helps reduce the impact of any single investment's poor performance on your overall portfolio.

Position sizing determines how much capital you allocate to each investment. Most experienced investors avoid concentrating more than 3% of their portfolio in any single share to limit exposure to company-specific risks.

Market timing remains challenging even for professional investors. Regular investing through pound-cost averaging can help smooth out market volatility by spreading purchases across different price levels over time.

Understanding your risk tolerance and investment timeframe helps determine appropriate asset allocation between shares, bonds, and other investment types within your portfolio.

How to invest in shares

1. Research forms the foundation of successful share investing. Analyse company financial statements, understand the business model, and evaluate competitive positioning before making investment decisions. Consider both quantitative metrics and qualitative factors when assessing potential investments.
2. IG Invest provides access to thousands of shares and ETFs through our user-friendly mobile app. Our platform offers research tools, market data, and portfolio tracking to support your investment decisions.
3. Search for specific companies or browse by sector to find investment opportunities that align with your strategy. Our platform provides real-time prices, company news, and analyst recommendations to inform your choices.
4. Choose the number of shares or monetary amount you wish to invest, considering your overall portfolio allocation and risk management strategy before placing your order.
5. Place your trade through our secure platform, with options for immediate execution or limit orders that execute when shares reach your target price level.

If you prefer IG professionals to invest and manage your money for you, the IG Smart Portfolio might be an alternative option.

Building a long-term investment strategy

Successful share investing requires patience and discipline. Market volatility creates short-term fluctuations that can test investor resolve, but history demonstrates that well-diversified portfolios tend to grow over extended periods.

Regular portfolio reviews help ensure your investments remain aligned with your financial goals and risk tolerance. Rebalancing involves selling outperforming assets and buying underperforming ones to maintain target allocations.

Tax efficiency considerations include utilising individual savings accounts (ISAs) and self-invested personal pensions (SIPPs) to shelter investment gains from taxation. Share dealing within these tax-advantaged accounts can significantly enhance long-term returns.

Educational development through reading financial publications, attending seminars, and learning from experienced investors helps improve decision-making capabilities and investment outcomes over time.