The biggest question on your lips right now is probably "how can I cash in on investing"? In essence, there are 3 main ways in which you can make money when investing in stocks and shares:
- Capital gains
- The magic of compound interest
So here’s a run down of what they are and how you can start cash in on investing.
What is investing?
Investing in stocks and shares refers to the practice of using money to buy shares of ownership in a company. When you buy shares of a company, you become a shareholder and are entitled to a portion of the company's profits and assets.
When a company makes a profit, it can choose to distribute a portion of that profit to its shareholders in the form of dividends. In addition, if the company's stock price increases, you can sell your shares for a profit. Investing in stocks and shares can provide a way to grow your wealth and achieve your financial goals.
You can make money investing when your investments’ increase in value, also known as capital gains. This refers to the profit an investor accumulates when they sell a capital asset for a price that is higher than the purchase price. For example, a stock’s market price will fluctuate over time – ideally, the company grows and makes more money, which increases its value overall. Then, because that total value gets spread across all the company’s shares, the market price per share would increase in order to reflect the value of the company. Meaning you can sell them off for a profit.
For example, let’s say the market price of company X’s stock is £5, and you buy ten shares of it. The value of your investments is then 10 x 5 or £50. Let’s assume company X performs well, and its stock is now selling for £6. Well, you still own ten shares of it, so that means the value of your investments is now 10 x 6 or £60. You only paid £50 originally, so if you were to sell those shares now, you’d have £10 more than you started with, which means you’ve earned £10 in returns. So, when you sell the asset for a higher price than you paid for it, the difference between the sale price and the purchase price is your capital gain.
To maximise your capital gains when investing, it's important to carefully research and select assets that are likely to increase in value over time. You should also consider factors such as taxes and fees, which can eat into your profits. Overall, making money from capital gains requires a combination of careful planning, research and patience.
Dividend payments are distributions of a portion of a company's profits to its shareholders, and are a key way that investors make money investing. When a company makes a profit, it can choose to distribute a portion of that profit to its shareholders in the form of dividends. The amount of the dividend payment is determined by the company's board of directors, and it is typically expressed as a dollar amount per share.
“Compound interest is the 8th wonder of the world. He who understands it, earns it. He who doesn’t, pays it” – Albert Einstein
For example, if a company declares a dividend payment of £1 per share and you own 100 shares of the company, you will receive a dividend payment of £100. Dividend payments are typically paid on a regular basis, such as quarterly or annually.
Note: Not all companies pay out dividends!
That’s right – not all companies pay dividends, and the decision to pay dividends is entirely at the discretion of the company's board of directors.
To maximize your dividend income, you can focus on investing in companies that have a history of consistently paying dividends and that offer higher dividend yields. You can also consider reinvesting your dividends by using them to purchase additional shares of the company, which can help to increase your dividend income over time.
In addition to carefully selecting the companies that you invest in, it's also important to consider factors such as taxes and fees, which can eat into your profits. Overall, making money from dividends requires a combination of careful planning, research, and a long-term investment strategy.
The magic of compound interest
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” – Albert Einstein
Compound interest is often referred to as the "eighth wonder of the world" because of its ability to generate wealth over time. Compound interest is the interest that is earned on both the principal amount and the accumulated interest of an investment. This means that the longer you invest your money, the more interest it will earn, and the more your money will grow.
Let's say you invest £100 at a 5% annual interest rate, and you leave the money invested for 10 years. After the first year, your investment will have earned £5 in interest, for a total of £105. In the second year, your investment will earn interest on the original £100 plus the £5 in interest earned in the first year, for a total of £5.25 in interest. This process continues, with your investment earning more interest each year, until after 10 years, your investment will have grown to £163.59.
The power of compound interest lies in its ability to generate wealth over time. As the above example shows, even a small investment can grow significantly with the help of compound interest. This is why many financial experts recommend starting to invest as early as possible and taking advantage of the power of compound interest to build wealth.
Historically compound interest has been incredibly powerful. Basically, when you invest your money, it hopefully earns returns, and then the returns you’ve earned can also earn returns of their own. Of course, this can also go the other way during down markets, but over the long term, markets have trended upward.
The bottom line
There are different ways you can make money when investing in stocks and shares, which work together to total up your return on investment. Capital gains is the one you should be most aware of, as this is when you have the potential to sell off your shares for higher than you bought them for. Meanwhile. Some companies also pay regular income in the form of dividends, which can offer investors a regular stream of income. When deciding which companies to invest in, it’s worth considering whether you want to prioritise a company that also pays out dividends.