Investing is one of those things that most people think they should do, but no one ever tells you exactly how it works, why it’s important, or even where to go to set up an account or get advice from a professional. Despite its importance, none of these topics are covered in schools or even colleges, leaving many young people in the UK in the dark and having to find their own way into the world of investments.
Investing can mean a number of things, it’s a catch-all term for a whole load of different options of how to spend your time and money. Here, I’m of course talking about the most common form of investing for the average person: the stock market. You in particular may already be an expert in another area of investing, be that in anything from cryptocurrency to regular currencies, luxury watches to real estate. If you believe you already are an expert or at least know what you’re doing in one of these areas, by all means, feel free to skip over this section. However, I’m betting the majority of young people today don’t know where to get started or how much it all costs.
So, the stock market, the catch-all term for that complicated and dangerous place that bankers and traders in the movies spend all their time running around frantically and shouting at each other. This is at least what I thought of these places before I knew anything about the topic, with all expectations coming from Hollywood movies like Margin Call and The Wolf of Wall Street. In reality, it’s a much calmer and more stable place that doesn’t actually exist in one single location. Put simply, the stock market is anywhere you are able to buy and sell stocks. The question you should really be asking yourself is what is a stock?
For those looking for a quick answer and to move swiftly on, a stock is a small piece of a company that someone owns, also sometimes called a share, that’s all. However, there are in fact a few things you need to get your head around first to fully understand how stocks work: what a stock is, why they give higher returns than a normal savings account, what it means to own them, and where you can buy and sell stocks and similar investments.
The real reason that the money in your bank account isn’t earning much interest at all is because you aren’t taking any risk with your money. Banks mainly offer interest in order to keep you as a customer, paying you interest at around the same rate as competing banks and building societies. In their eyes, this is a small price to pay for the value they get out of you. After all, banks make money from you in all sorts of ways: lending out your money to businesses at much higher interest rates; charging you fees on any overdrafts you might have with them, or the benefits they’d get from you taking out a mortgage or personal loan with them. Because of the security that banks offer, the only real risk you face in depositing your money with a regular bank is the very small possibility that the bank fails or is in some way hacked, resulting in you losing your money. Even in this case, you have the government-backed FSCS (Financial Services Compensation Scheme) to fall back on, which will provide you with up to £85,000 in compensation for the money lost in any single account.
Imagine that instead of putting your money into a bank account, you chose to loan your money to another person, company or other institution. You are likely to demand a higher rate of interest because of the risk you’re taking. In this case, there is a reasonably foreseeable chance that either an individual will not want to, or be unable to pay it back when you ask them to. Likewise, a business may never make enough money to repay your loan, or an institution you thought was legitimate could turn out to be a front for a scam.
Granted these are worst-case scenarios, but they demonstrate that there is a risk here. When lending, you or whoever is giving out cash is likely to charge interest on the loan according to how risky the venture is. A loan to a large company with a proven track record, such as Apple or Amazon might be able to get hold of a loan at around a 5% interest rate for example. Whereas, a small, recently founded company such as ThisIsAScam Ltd or BunchOfIdiots LLP is obviously quite a high risk and will have to fork out much higher rates of interest on their loans in order to compensate the lender (you!) for the higher risk they’re taking.