06 February 2015

What’s the difference between stocks and shares?

It’s a question that most people interested in investing are probably too embarrassed to ask. They shouldn’t be. Although little distinction is made these days between the two parts of the phrase, ‘stocks and shares’, the words do have slightly different histories – and those histories say a lot about the way that investing has evolved through the years.

On one level, ‘stocks’ and ‘shares’ mean the same thing: small slices of companies that you own by virtue of having invested in them. However, the words ‘stocks’ and ‘shares’ imply different types of relationships to the companies that you own.

A ‘share’ in a company

A couple of years ago, a Dutch student uncovered what is currently thought to be the world’s oldest share certificate, issued in 1606 by the Dutch East India Company. Its existence was a result of the perils of the long voyage from The Netherlands to South East Asia. The expense and riskiness of these trips meant that Dutch merchants had to pool their resources when it came to financing them. They formed East India Companies in order to do this, and issued paper certificates to record how much each merchant had invested and therefore what slice of the company they owned, and what share of future profits they were owed. The Dutch East India Company took this to the next level by merging the existing companies together and issuing shares to the public as well as those in the trade.

The first shares were actually issued for set periods of several years that reflected how long a voyage to South East Asia and back would last. You couldn’t expect to get your money back until this time had elapsed. As a result, the ‘share’ represented a long-term relationship on both sides. Today the term ‘share’ implies a relationship to the company you invest in that evokes those paper certificates. When you use the term ‘share’ it refers to the recognisable stake that you have in the future of that company. Describing people as shareholders of a corporation tends to imply that they have a direct interest in the business. You might expect a shareholder to attend annual meetings, read annual reports, and approve or disapprove of the way the business is run.

‘Stocks’ to trade on a stock market

The invention of shares though, was quickly followed by another development that would eventually give us the term ‘stock market’. When the Dutch East India Company failed to redeem its early shares for money on the date originally planned, shareholders who wanted their money back then and there had little option but to sell their certificates onto others. A lively trade in this developed in an area then known as the Amsterdam ‘Bourse’. Speculation in how successful the Dutch East India Company would be in the future meant that the price of the shares varied and as the Dutch fortunes improved there was greater optimism – and shareholders stood to make considerable sums by selling their shares on. Over time, the term ‘stocks’ came to refer to shareholdings that were bought and sold in this way. It didn’t describe a direct relationship to a company, more a collection of assets that could be bought and sold to make money.

Today, stocks refer to investments in publicly traded companies that can be bought and sold on a stock exchange. The stocks that you are trading are shares, but by using the term stocks you imply that you have less long-term interest in the company you are investing in. If somebody tells you that they own shares, you might legitimately ask which company those shares are in – and how that company is doing. If somebody tells you that they invest in stocks, you wouldn’t necessarily expect them to know the details of which companies and how they are run. Stocks today can be traded quickly and frequently, and they no longer involve the issuing of share certificates that could be hung on the wall to show which companies you own slices of.

This isn’t to say that there aren’t people today with a traditional shareholder relationship to the companies they own slices of. When Royal Mail was privatised, for example, its employees were given shares in the business – and this direct relationship has more in common with those traditional share certificates than it does with the buying and selling of stocks. However, many investors in today’s stock market are unlikely to know exactly which companies they own.

Why many investors have both stocks and shares

In many ways, these investors are both ‘stocks’ and ‘shares’ investors, because their investment involves two different types of relationship. They own shares in investment funds, which pool the resources of many different investors to buy and sell a potentially broad range of stocks on the stock market. The investors in the fund technically own a slice of the companies that the fund has stock in, but they don’t tend to follow the finer details of which companies they own. In this way, investment funds make stocks and shares more accessible to a wider range of investors.

Important information

Please remember that with investments such as stocks & shares ISAs: the value of investments can fall as well as rise which means that you may not get back the amount you originally invested.

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