Stock investing: potential returns and risks

Stock investing lets you own part of a company and may provide a return through price gains or dividends. Shares can also fall in value, and a company may pay no dividend. Here is what share ownership means, how common labels differ, and what to examine before buying.

What are shares?

A share is an ownership interest in a company. Your rights depend on the type of share: some allow you to vote on company matters, while others have different terms. If the company distributes earnings to shareholders, you may receive a dividend. You might also sell for more than you paid. Neither result is assured: dividends can be reduced or skipped, and a sale can bring in less than the purchase cost.

The market price does not simply follow a company's revenue or profit. It also reflects buyers' expectations, wider market conditions and what investors are willing to pay now. Even a healthy business can be a losing investment at a particular purchase price.

Types of shares

Labels such as blue-chip, growth and defensive describe companies or investing styles. They are not fixed grades of safety or return. A company may fit more than one label, and the label can change over time.

• Blue-chip shares are associated with large, familiar companies with long track records. Public information may be easier to find, but size and reputation do not stop the price from falling. Dividends depend on company decisions.
• Growth shares attract investors expecting the business to expand. If performance misses those expectations, or the purchase price already reflects an overly optimistic future, the share price can fall.
• Cyclical shares belong to businesses more exposed to changes in economic activity and demand. Profits may move sharply through a cycle; the label alone cannot predict the next price move.
• Defensive shares are linked to products or services whose demand may hold up better in a downturn. That does not make their price steady or their dividends certain.
• Speculative shares depend heavily on uncertain business prospects or market expectations. Large possible gains come with the possibility of large losses.

A company's past share-price rise is not evidence of its future return. Look at its current business, the price you would pay and the loss you could bear, rather than past share-price gains.

You can buy individual shares or a fund that holds a basket of securities. A fund can spread exposure if its holdings are genuinely varied. A narrow fund may still depend on a single industry. Diversification reduces reliance on one company, but it cannot prevent a broad market decline.

How to buy shares

Begin with your goal and timeframe. If you will need the money on a set date, consider whether you could wait through a price drop or would have to sell at a loss.

Then work through these questions:

• What are you buying? Read about the company's business, financial statements, debt and the terms of the share. Check which rights that class of shares gives you.
• Where might a return come from? Separate possible dividends from the hope of selling at a higher price. Neither is a scheduled payment you can rely on.
• What could go wrong? Consider weaker sales, adverse news or a lower market price. Decide what loss your finances could absorb.
• What does trading cost? Compare a broker's fees and terms. Check its authorisation through the official register in your country. Authorisation does not protect you from a loss on the share itself.
• How does it fit with other holdings? Shares in different businesses or a diversified fund can reduce dependence on one company. Check whether a fund repeats assets you already own.

After buying, revisit the decision when your goals or important facts about the company change. A daily price move does not, by itself, call for a trade, and waiting for a supposedly perfect moment cannot guarantee a profit. If the terms are unclear, ask the intermediary or an independent professional before you buy.

To work out what you could set aside for investing, first look at everyday income and expenses. Moneon lets you record both and see where your money goes.