Stepping Stones Financial Planning

How do share markets work

There are many asset classes you can invest in and shares are just one type that you might find in an investment portfolio. But what are shares and how do they work?

What are shares?

Shares (also known as stocks or equities) are a portion of ownership in a company. Shares are generally issued by a company when it wants to raise money to help expand or fund its operations.

How can you access shares?

Shares are bought and sold through share markets or stock markets. In the past, shares were bought and sold through physical orders. Today it’s all done electronically – either through a broker or using an online platform which allows people to buy and sell shares themselves.

Investors can own shares directly or access them through structures like a managed fund or trust. A super fund may invest in shares as part of its investment strategy to help members grow their super balance.

What is a share market and how does it work?

Share markets are global marketplaces where investors can buy and sell. In Australia, we have many different share markets, including the ASX or Cboe Australia (CXA). Different markets may have access to different products or specialise in certain types of equities.

Many countries have their own share market for investing and can be classified differently. Developed markets include established nations like Australia, the United States and the United Kingdom. Emerging markets are nations whose economies are growing and developing, including Mexico and China.  

Companies listed in share markets are often organised into sectors, like communication services, consumer staples, energy, information technology, financials, health care, real estate or utilities. In Australia, supermarkets like Coles fall under the consumer staples sector while companies like Telstra fall under the communication services sector. 

What is the ASX 200 or the S&P 500?

To track the performance of investments over time, investors use a benchmark or index. A benchmark serves as a standard against which the performance of a specific asset class is measured.

There are hundreds of benchmarks that correspond to different share markets. Two that are commonly quoted in the media include the ASX 200, which is the official benchmark for the top 200 stocks listed on the Australian share market; and the S&P 500, which tracks the performance of the top 500 stocks listed on the United States stock market. Benchmarks help investors understand how share markets are performing generally.

What can impact share prices?

Share prices may increase or decrease over time. There are many factors that influence a share price, like the value or performance of the underlying company. It can also fluctuate based on demand – if a lot of investors are all interested in a particular share, the limited supply will drive the price up. 

External factors can also influence share prices, including industrial and economic developments, wars, pandemics, civil unrest – and even the weather! 

These fluctuations make shares one of the higher risk asset classes. In exchange for this risk, shares have the potential to deliver higher investment returns to investors over the long term compared to less risky investments.

How do shares generate investment returns?

By owning shares in a company, you are entitled to a portion of the profits that the company makes – generally paid as dividends.

The share’s value can also increase over time, meaning you can sell the share for a higher price than you paid originally which is a return through capital growth. 

Why invest in Australian and Global shares?

Australian and global shares have the potential to provide strong returns over a long period of time. They also bring with them a risk of potential loss in the short term. For this reason, many investors with decades to retirement may choose investments in shares since they generally have more time to ride out market fluctuations and generate returns. Your willingness to face that loss can be driven by a number of factors called your risk profile. This includes your age, years to retirement and personal circumstances.

Note: There may be tax implications involved with investing in shares that could have an impact on an individual’s returns. Speak to a financial adviser for more information.

Source: Colonial First State (CFS)

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