How to invest in the stock market: a beginner’s guide

To a beginner, the stock market can appear rather daunting, but it’s never been more important to top up your knowledge and take control of your financial future.

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A key reason to learn more about investing is because most people today – particularly those under the age of 40 – have pensions that are linked to the stock market. In previous decades, the norm was a salary-related pension, in which the amount of income paid at retirement was based on how long the individual had been a member of the pension scheme and their earnings. Such pensions still exist but are in terminal decline and it’s more common for individuals to save for retirement in an investment-based pension, known as a defined contribution pension.

As a result, the onus has shifted to individuals to take control of their financial future. By becoming engaged with how your pension is invested, and saving in a stocks and shares ISA, for example, there’s a greater chance of reaching your financial goals.

Below, we explain how to invest in the stock market, but first we share three tests that anyone who wants to invest should pass before getting started.

Before you invest, pass these tests

First, everyone should have some “rainy day” money for emergencies, ideally three to six months’ salary held in cash. Then, if the unexpected happens, such as redundancy or a broken boiler, and you need to access cash in a hurry, you can do so easily and won’t be forced to sell your investments during a potentially disadvantageous time.

Second, clear any debts, tackling the most expensive ones first. While it’s important to have savings, it’s not normally a good idea to prioritise additional savings over reducing debts, because debts usually cost more in interest than savings earn. Mortgage debt is not normally considered debt in this scenario.

The final test is a commitment to invest for at least five years, as over the short term the stock market can be unforgiving.

How risky is investing?

The reality is that every investment has an element of risk and there are no guarantees that you will make a profit.

Cash is safer than the stock market, but it would be a mistake to think cash is completely “risk free”. While £100 will always be at least £100, the effect of inflation means the best way to attempt to grow wealth in real terms is to invest.

According to Barclays’ Equity Gilt Study 2024, UK stocks have on average returned 3.1% a year in real (inflation-adjusted) terms over 20 years. In contrast, cash has lost 1.8% and US shares have fared better, up by 6.4% a year over the same period.

How much investment risk you are willing to stomach – known as risk appetite – is a personal decision as only you can decide what level of risk you can tolerate emotionally and relative to your financial circumstances and time horizon.

But there are things that investors can do to manage risk:

Invest for the long term

Ideally five years or more. This means that if prices do fall, there’s time for them to recover. History tells us that when stock markets fall sharply, they typically bounce back, often very quickly. Investors just need to be patient and not turn paper losses into real losses.

Owning a range of different investments

This is another great way to reduce risk. It might mean buying shares in different companies or investing in a fund that does it for you. It just spreads your risk. If one or two fall in value, hopefully the rest will do better. This is known as diversification.

Invest regularlyrather than all at once

Investing regularly, such as at the same time each month, removes the risk that you might put all your money into the market just as prices fall. Investing the same amount at the same time each month smooths out the volatility. Regular investing is free at interactive investor (although usual trading fees apply when you sell).

Rebalance your portfolio twice a year

This just means taking a bit of profit from your winners and maybe buying more of the investments that haven’t done well yet. This might seem counter-intuitive, but it does help maintain an appropriate level of investment risk.

• What are the main assets to invest in a stocks and shares ISA?

The basics

In the UK, the main stock market is the London Stock Exchange, where public limited companies and other financial instruments such as government bonds are bought and sold.

The stock market is split into different indices, with the most famous in the UK being the FTSE 100, comprising the largest 100 companies.

The most well-known indices come from the FTSE group: the FTSE 100, the FTSE 250 and FTSE All-Share. There’s also the alternative investment market (AIM), which mainly lists small and venture capital-backed companies. AIM shares can be more volatile than traditional investments and are often viewed as riskier than more established companies on the main market.

In the US, the main stock market is the S&P 500 index, comprising the largest 500 US companies. Other US stock markets include the Nasdaq, which contains technology stocks, and the Dow Jones, the world’s oldest index of stocks, dating back to the late 19th century. 

• How to own the world through index funds and ETFs

How to invest

In our 21st-century world of electronic trading, the ability to buy and sell shares is at the fingertips of anyone with an internet connection.

Investing in the stock market is always done through a third party, such as an investment platform. 

Online investment platforms, such as interactive investor, allow investors to buy and sell shares, bonds and gilts, funds, investment trusts and exchange-traded funds (ETFs). The onus is on the individual to select the investments – no financial advice is offered.

Do-it-yourself (DIY) investors must set their own financial goals and carry out research ahead of making an investment. Understanding how a fund invests and what it’s aiming to achieve puts investors in a good position to act if performance isn’t up to scratch.

The investment options: funds, trusts, and ETFs

There are two ways to access the stock market: directly and indirectly. Although the term “directly” is a misnomer, as mentioned above, since investing in the stock market is always done through a third party.

Direct investment means buying shares in a company and becoming a shareholder.

This route requires time and effort on the part of the DIY investor, who needs to get to grips with concerns including how the business makes money, current and future risks, and whether the share price valuation is viewed by the market as “cheap” or “expensive”.

An indirect approach is a more common way of accessing shares, as it spreads risk by investing in several companies.

This can be achieved via an open-ended fund, which are structured as an Open-Ended Investment Company (OEIC) or unit trust. Funds are a type of pooled investment that invest in a “basket” of underlying assets such as shares, bonds or property. Funds typically hold between 50 and 100 companies to spread risk.

Funds tend to invest in a certain region (such as the UK) or sector (such as technology) and either invest for growth, income, or a combination of the two. Those with an income mandate generate a certain amount of income that’s returned to investors over a specified period (such as quarterly or twice a year) in the form of dividend payments.

Money in funds is ring-fenced, so if the firm defaults £85,000 of your money is protected by the Financial Services Compensation Scheme (FSCS). However, it does not protect your deposits in instances where your money has been invested and loses value.

An investment trust is another pooled investment, but unlike funds trusts are listed on the London Stock Exchange.

There are two “layers” of activity: the performance of the underlying investments held in the investment trust, and its share price. The shares are traded on the stock market. The share price goes up and down according to investor demand and supply, but the fund manager’s investment plans are not affected.

Investment trusts have various structural advantages that benefit private investors, particularly those investing for income. You can find out more here.

While most investment funds and trusts are actively managed products, run by a fund manager who handpicks shares and has some direction over the performance of the fund, exchange-traded funds (ETFs) and index funds passively track the ups and downs of a stock market index.

Both ETFs and index funds offer investors a simple way to “buy the market” at a cheap price, with some ETFs and index funds costing less than 0.1% a year to track the performance of the US and UK markets, which works out at £10 on a £10,000 investment. Bear in mind that the performance will not be completely mirrored, owing to the fee levied among other factors.

ETFs and index funds will, in theory, be cheaper than funds or investment trusts, as there is no active manager to pay. But it’s worth checking the annual charge, as some index funds launched decades ago are charging higher fees than competitors.

By selecting a passive fund, an investor will get an index-like performance minus fees. The investment will rise and fall with the index, so in the event of the index falling spectacularly, so will your investment.

Check out our separate guide that goes into more detail about the pros and cons of funds, investment trusts, ETFs and shares.

• What to invest in when getting started: a beginner's guide

Why collective investment funds suit beginners

Beginner investors are best suited to using collective investment funds to access the stock market, as it enables them to use the collective buying power of a fund to reduce charges on a small starter portfolio.

It also means the professional fund manager buys and sells the individual shares, so the individual investor doesn’t have to make their own investment decisions.

Other reasons why people use funds or trusts

Diversification: you can pool money with other investors and spread your risk among a large portfolio of stocks that you could not access with smaller amounts of money

Time: monitoring large portfolios is a time-consuming process

Access: some overseas and emerging markets are difficult to access as a DIY investor

Cost: some funds, particularly index funds and ETFs, and some investment trusts, offer very cheap ways to buy a portfolio. Several passive funds cost less than 0.1%

Asset allocation: some investors may have a direct portfolio of UK shares but need to spread risk among other assets, such as commercial property and corporate bonds, using funds or investment trusts.

Funds for starter investors

Building your own portfolio takes time and effort. There are, however, shortcut options for those who prefer a more hands-off approach, and investors can outsource the decision-making over what to hold. Broadly speaking, there are two types of strategy. Some multi-asset funds directly invest in shares and bonds, while others, known as “multi-manager” or “fund of funds”, buy other funds.

Such funds split your money across a mix of different assets, which tend to perform differently in different market conditions, to avoid large fluctuations in overall value.

Be aware that the amount you pay to buy a multi-manager fund is significantly higher than other funds. Yearly charge figures are usually north of 1.5%, versus 0.85% to 1% for most other funds.

To cut down on costs, options include multi-asset funds that track the market. These funds invest in a spread of assets by using index trackers and ETFs, which aim to mirror the performance of a particular stock market or bond market.

The funds have different risk levels. Basically, the more shares they have, the higher risk the fund. These fund ranges include Vanguard LifeStrategy, BlackRock MyMap, Legal & General Investment Management’s Multi-Index funds and Aberdeen’s MyFolio Index range.

interactive investor’s Managed ISA

Our own Managed ISA aims to keep things very simple, using index funds and ETFs to create two low-cost multi-asset portfolio ranges that will suit different risk tolerances.

Once you’ve answered a few questions, you will be matched to one of the 10 portfolios. The one selected will be based on your risk level and whether you want to invest sustainably.

For the other options covered above, such as multi-asset funds, you will need to select your own investments. In contrast, our Managed ISA does this for you.

• Three hassle-free ways to invest your ISA

Quick-start Funds

Interactive investor has a Quick-start Funds range to help make investing easy. They are like ready-made portfolios and give you access to the world’s markets. We offer a choice of three passively managed funds from Vanguard – these track the various asset classes with little intervention from a fund manager – and three actively managed funds from Royal London, where a fund manager makes decisions on what to invest in and when. 

Well-diversified global funds, investment trusts and ETFs tracking a global index are also potential good fits for beginner investors. Among the candidates for those seeking actively managed global funds are F&C Investment Trust (LSE:FCIT) and Alliance Witan (LSE:ALW). The duo own hundreds of global shares across various industries and sectors, which spreads risk far and wide.

What else to be aware of

Before committing money to the stock market, decide what you want to achieve, how long you are planning to invest for, and how much risk you are prepared to take. You must understand your tolerance for risk rather than appetite for reward. Every investor must consider the potential downsides before getting started.

Tales of other people’s huge gains sound tempting, but the market won’t always move in your favour, and you must be prepared to see your investment fall as well as rise.

Investors ought to understand what they are investing in. To do that, always read the fund factsheet and other literature.

The costs involved in buying funds, trusts, shares, or ETFs can vary hugely, and higher fees can easily eat away at future returns. To ensure value for money, compare charges on different products. As an investor, the only thing that you can control is costs.

The final point to stress is that investments should be held for at least five years to smooth out any bumps in the market, but that doesn’t mean that investments should be left unchecked. Review investments regularly, perhaps every six months, to ensure that they are performing in line with expectations. If they aren’t, try and understand why and then look to make changes if appropriate.