Where and how share trading takes place
Trading takes place on stock exchanges such as the London Stock Exchange (LSE) for UK companies, the New York Stock Exchange (NYSE) for large United States (US) firms, and the National Association of Securities Dealers Automated Quotations (NASDAQ) for technology-focused stocks. Depending on your desired level of involvement, brokers offer various services.
Full-service brokers manage your portfolio, advisory brokers offer recommendations, and execution-only brokers simply carry out your trades. Trading hours are limited to when the exchange is open, which varies by region and season.
Modern technology has revolutionised share trading, with online platforms providing real-time market data and instant execution capabilities. This democratisation of investing has made share ownership accessible to a broader range of investors.
Trading platforms now offer sophisticated tools previously available only to professional traders, including advanced charting capabilities, research reports, and risk management features.
Understanding dividends and income generation
Aside from price gains, shares can also generate income through dividends – cash payments made from a company’s profits. Companies that are still growing often reinvest their profits and don’t pay dividends, aiming instead for higher share price appreciation.
More mature companies, however, tend to distribute regular dividends, offering a steadier investment return. When private companies go public via an IPO, they allow ordinary investors to buy shares for the first time.
Dividend policy varies significantly between companies and sectors. Technology companies typically reinvest profits into research and development, while utilities and consumer staples often provide consistent dividend payments.
Understanding a company’s dividend history and policy helps investors align their investment strategy with their income requirements and risk tolerance preferences.
The power of dividend reinvestment
Now, let’s look at how total return – an investor’s actual performance when dividends are reinvested – can make a dramatic difference over time. Consider a FTSE 100 stock that pays a 4% annual dividend.
If the share price grows at an average of 3% per year over five years, without reinvesting dividends, the capital gain alone would give a 15.9% return. However, reinvesting those dividends each year compounds the income.
Assuming the dividends are reinvested annually, the total return over five years rises to approximately 34%, not just 15.9%. This demonstrates how reinvesting dividends can nearly double your effective return.
The compounding effect becomes more pronounced over longer periods, turning modest gains into significantly greater long-term wealth through the mathematical power of exponential growth.
Real-world example of share investment returns
Taking a real-world example, let’s say you invested £10,000 in a FTSE 100 stock like Unilever in July 2020, with a dividend yield of around 3.5% and annual share price appreciation averaging 2.5%.
Without reinvestment, your investment might grow to around £11,315 after five years. But with dividends reinvested, your investment would be worth approximately £12,100.
This 21% total return versus an 11.3% capital return highlights the importance of considering not just share price movements but also dividend policy when evaluating long-term share performance.
These calculations illustrate why professional investors focus on total return rather than price appreciation alone when assessing investment performance and making portfolio allocation decisions.
Different types of shares and markets
Beyond ordinary shares, investors can choose from various equity instruments including preference shares, which typically offer higher dividends but limited voting rights. Exchange-traded funds (ETFs) provide exposure to diversified portfolios of shares through a single investment.
Growth shares focus on capital appreciation, while value shares trade below their perceived intrinsic value. Income shares prioritise dividend payments over growth, appealing to investors seeking regular cash flow from their investments.
International markets offer additional opportunities, though they introduce currency risk and regulatory differences. Emerging markets potentially provide higher returns but with increased volatility and political risk.
Sector-specific considerations also matter, with defensive sectors like utilities performing differently from cyclical sectors like construction during various economic conditions.