If reader requests are anything to go by, sound financial advice and information is something that many are looking for. This issue we look at the stock market. Not just for big companies or the insanely rich – it can be a simple, rewarding process, according to Jaimie Kanwar.

At first glance, the stock market appears to be a confusing mass of complex terminology and abstract concepts, but once you get past the initial confusion, investing in the stock market isn’t as scary as you might think.

WHAT IS THE STOCK MARKET?
The expression “stock market” refers to a financial arena where company shares are bought and sold. The buying and selling process takes place through an exchange – an organization that provides “marketplace” for stockbrokers and traders.

Almost all countries with a developed economy have their own stock market, and these are often driven by more than one exchange. In the UK, the main entities are the London Stock Exchange (LSE) and – for smaller companies – the Alternative Investment Market. In the USA, the two main exchanges are the New York Stock Exchange and the fully computerised National Association of Securities Dealers Automated Quoted System (NASDAQ).

The stock market is distinct from the Bond Market – also known as the debt, credit, or fixed income market – where participants buy and sell debt securities, usually in the form of bonds.

STOCKS, SHARES AND BONDS
So what exactly is a share? Basically, it’s a unit of ownership in a company, and the terms “stocks” and “shares” are widely accepted to be interchangeable. When you buy shares – whether it’s one or a one thousand – you become a shareholder and part of the business.

Thus, if a company issues 1,000 stocks in total and you buy 100 shares (ie, pieces of stock), you would own 10% of the company. One of the main benefits of being a shareholder is the payment of dividends – cash bonus payments made to shareholders when a company earns a profit or surplus.

A bond is basically a loan in the form of a security, but with different terminology: the bond issuer is equivalent to the borrower and the bond holder is equivalent to the lender. Bonds and stocks are both securities, but the difference between the two is that shareholders have an ownership stake in the company.

BUYING SHARES
There are two main modes of buying shares: the purchase of existing shares already on the stock market, or new shares put out when a company releases them to raise money for the business.

Share values are affected by a number of things, but the main price determinant is a company’s performance. When a company is performing well, share price tends to increase, whilst poor performance tends to have a negative effect on the share value.

Ideally, you should buy shares when they are at their lowest price and sell them when they are at their highest. Of course, this is easier said than done, and anticipating market trends and fluctuations is something that even the experts can get wrong.

USING A STOCKBROKER
The buying and selling of shares can become complicated, so it’s always a good idea to employ a financial adviser, stockbroker or investment manager to act on your behalf.

Stockbrokers, for instance can be utilized in the following ways:

Execution only
Buy/sell shares according to your instructions, providing no advice whatsoever.

Advisory
Provide advice and execute the buy/sell decisions you make.

Discretionary
Buy/sell shares on your behalf with authority to make decisions without your prior approval.

Under the Financial Services Act 1986, stockbrokers and professional advisers are legally obliged to inform their clients of all charges being made. Although price is not the only feature you should use to choose a stockbroker, most of the large, well-known brokers will charge a minimum fee of between £10 and £20 per transaction.

IMPORTANT THINGS TO CONSIDER
There are factors to consider before investing in shares, the most important of which are as follows:

RATES OF COMISSION
Different rates of commission are charged on the various types of stocks and shares. Basically, ordinary shares, convertibles and foreign stocks attract the highest rates of commission, and government securities, permanent interest-bearing shares (PIBS), and loan stocks, the lowest rates.

ECONOMIC CYCLES
The stock market follows economic cycles so that there are periods of upward movement (bull markets or phases) followed by periods of decline (bear markets or phases). Ideal timing involves buying shares in bull phases and selling when the evidence suggests that a long bear phase is about to set in.

COMPANY ISSUES
Positive and negative events directly affecting a company can have an impact on share prices. Significant events to look out for include the publication of financial results, external bids for the company, potential mergers, changes in the capital structure and acquisitions of other businesses.

MARKET VOLATILITY
In the short term, the market frequently over-reacts to information and rumour, as was recently shown when Halifax Bank of Scotland shares dropped almost 18% because of false rumours about their financial strength. Investors who do not take this into account run the risk of buying “at the top” (when prices are most expensive) and missing the opportunity to buy lower down on the reaction, when prices are cheaper.

THE BENEFITS OF LONG-TERM INVESTING
World-renowned stock market investor Warren Buffett once said: “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” Buffett – recently ranked by Forbes magazine as the richest man in the world – has always been a strong believer in the long term potential of the stock market.
In many cases, smaller scale investors find that when it comes to stocks and shares, patience is most definitely a virtue.

Countless research studies have shown that long term investment in the stock market usually produces better results
than other forms of investment. The Barclays Equity Gilt Study – perhaps the world’s most respected investment study – has found that over most 10 year periods, shares have always performed better than cash.

With long-term investing, the basic rule is not to invest any money you might need in the next five years – say, for a deposit on a house or some other important reason. If that’s the case, you’re probably better with a cash savings account. If, however, you want to save your money for 15 or 20 years, then it’s not really a problem if fund performance dips in the early days.

WHERE CAN I FIND A STOCKBROKER?
A list of reputable brokers can be obtained free of charge from the London Stock Exchange or from the Association of Private Client Investment Managers and Stockbrokers (APCIMS), a trade body that provides contact details and areas of service of all its member brokers.

Detailed guidance on investing in the Stock Market can be found on leading consumer finance website The Motley Fool website: http://www.fool.com/school/basics/basics03.htm

HOW THE STOCK MARKET WORKS IN PRACTICE
Here is a practical example of how the stock market works:

1. You open a trading account with E-Stock (not a real company) and deposit £1,000 into the account.

2. You place an order with E-Stock for 100 shares in Company A, which is
currently trading at £5 per share.

3. E-Stock (or your Broker) finds someone who is willing to sell 100 shares of Company A.

4. Once found, E-Stock facilitates the trading of stock between you and the person selling the shares.

5. The trade information is sent to a clearinghouse where the transaction is processed.

6. The clearinghouse then transfers 100 shares of Company A to E-Stock

7. E-Stock transfers the shares to you, which are then registered in your name.

The stock market is ultimately just like any other marketplace – it facilitates the exchange of goods between interested parties and works to reduce distribution costs and set prices.

INHERITANCE ISSUES
When it comes to passing on your stocks and shares to loved ones, the usual probate rules apply:

1. No Inheritance tax (IHT) is paid on any transfer of assets on death from husband to wife or vice versa.

2. If the stocks and shares are held in the name of two or more people and one of those dies, the remaining account holders inherit the balance free of any liability IHT.

3. Most gifts made more than seven years before your death exempt from IHT, so stocks and shares could safely be transferred to children in this timeframe.

4. If the stocks and shares are in one person’s name, then they will form part of the deceased’s estate, which will be liable for IHT at 40% if the total monetary value of the estate is above the IHT threshold (currently set at £312,000 for tax year 2008-09).

For Example, Mr John Smith dies and leaves the following assets:

• House = £330,000
• Car = £7,500
• Household Goods = £2,000
• Bank account = £19,250
• Shares = £30,075
• Premium Bonds = £500

Total value of Mr Smith’s estate = £387,240. This is above the IHT threshold of £312,000, so tax will be payable on the amount above £312,000, which is £75,240. This final IHT payment will therefore be 40% of £75,240, which is £30,096. You can obtain a clear and comprehensive overview of IHT on the DirectGov website: http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/InheritanceTaxEstatesAndTrusts/DG_4016736

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