If you were investing in a house you’d hope you would generate a return from the housing market rising, which means you can sell it for more than you bought it. The same applies to investing for growth in the stock market.
By owning shares, you are buying into companies that you anticipate will turn a profit and increase in value, meaning you can sell your stake (even if it’s tiny, like a few hundred shares of Apple’s multiple billions), for more than you bought it, making money, or to use some jargon, realising “capital gain”.
This growth may be as a result of buying shares in companies that you think are undervalued, or by investing in companies that you see potential in, perhaps they are young or emerging and you believe that with time they’ll become more successful than their competitors.
There is another way to generate return on stocks and shares, however, and this is through dividends. Dividends are a proportion of a company’s profit, paid out to shareholders. The size of dividends are decided each year by the company directors, anything not paid in dividends may be invested back into the business.
Unlike putting your money in a cash savings account, where it is clear in the terms and conditions how much return you will receive paid in interest, how much return you will receive on investments is not clear cut. No one has a crystal ball. Will the company you invest your money in have a great year? Or will it suffer because, for example, a global pandemic comes along and shuts down a whole sector of the economy out of the blue?
There are lots of ways in which you can make informed predictions about how companies, the economy, and the overall stock market might perform, however, from considering where you and your friends like to spend your money, to keeping an eye on politics, to believing in the fundamentals of a business and the board that runs it.
You may also look at the past performance of a company, share or fund, looking to see if it weathers storms well or has consistently grown year on year.
But past performance is no guarantee of future performance, and you should always keep that in mind.
Investment is, therefore, inherently risky. The fortunes of the company or market you invest in could fall as well as rise. That’s why it is important to protect yourself from unnecessary risk, by for example, investing over the long term, and diversifying. If all your money is in one company, and that company fails, your money is gone. If it’s spread between several, so is your risk.
When you realise any returns on an investment, whether that is capital growth or profiting from dividends, you need to pay capital gains and dividends tax on them above the 2021/2022 tax-free allowance threshold of £12,300 on capital gains and £2,000 on dividends. That is where ISAs come in, any return earned within an ISA is tax-free, forever. If you expect to earn more returns than your allowance will cover, you should make sure you invest using an ISA.
Remember, as with all investing your Capital at risk.
The value of your investments can go down as well as up and you may get back less than your original investment. Past performance is not a reliable guide to future returns. Rates of tax, reliefs from them and allowances can change without notice as can the tax status of investments.
Remember your Capital is at Risk and past performance is not a reliable guide to future returns. The value of your investment can go down as well as up and you might get back less than you originally invested.