Types of shares to invest in

You can invest in many types of shares, each offering unique risk and reward profiles. In this article, we look at some of the major types of stocks and explain how you can use them to build a strong portfolio that can weather even the worst economic storm.

What is a share?

A share is a small ownership stake in a public company. It gives the holder certain privileges, such as voting rights and dividends (if the company pays them). Owning shares also can deliver investors capital gains when the company does well and its share price increases along with the company value or market capitalisation. 

That's the reward. The flipside risk is that the company's share price falls (for whatever reason), and the shareholder loses on their investment.

Shareholders also get to vote on certain company matters, which gives them a say in the direction of the company they're invested in. Many corporate actions require shareholder approval, including changes to the company's board, potential mergers and acquisitions (M&As), and any significant changes to company operations.

Why do companies issue shares?

Companies can raise the capital required to run their operations in a few ways. They can borrow it from lenders, sell company shares or reinvest profits into their business. However, it depends on whether they are public or private entities.

A public company – one listed on a stock exchange such as the Australian Securities Exchange (ASX) – can issue new shares through a placement to raise additional capital.

If a private company – not listed on a stock exchange – wants to raise money by selling shares, it must fulfil the criteria required to list as a public company and participate in an initial public offering (IPO). 

And why do investors buy them?

Investors buy shares hoping to earn a return from dividends or capital gains (or both). Different classes of shares offer different return profiles and may suit different types of investors.

Investors with a high-risk tolerance might buy growth shares in more speculative companies hoping to make a significant capital gain if the share price takes off. Investors with a lower risk tolerance or hoping to generate extra income through dividends might buy shares in mature blue-chip companies.

Blue chips may not offer investors the same potential capital gain as a junior growth stock – but their prices are likely to be less volatile, and they'll probably pay a chunky dividend.

What's the difference between a share and a stock?

Most Australians use the terms 'share' and 'stock' interchangeably, but technically there is a subtle difference.

A share typically refers to a specific company and represents the smallest unit of ownership you can hold (ignoring fractional shares). For example, you might say you own 100 shares in the Commonwealth Bank of Australia (ASX: CBA). This tells your audience exactly how much of an ownership stake you have in CBA.

On the other hand, stock is a general term that refers more broadly to company equity. So, you might say you own stock in CBA. This tells your audience that you have an ownership stake in CBA without conveying the exact number of units you hold.

This distinction is a bit in the weeds these days, and most people don't seem to worry about it. Also, you might find that 'stock' is more commonly used in American English, whereas in Australia, we are more likely to use the word 'shares'. Either way, I wouldn't get too hung up about it.

In a nutshell, how does share trading work?

We have already covered why investors buy shares. They want to profit by receiving dividends or making a capital gain (or ideally both). One of the main goals of share trading is to buy shares when they're cheap and sell them when they're expensive to try and lock in a gain.

To predict which shares will increase in value, share traders analyse market trends, company reports and other economic data. They will then invest in companies that best fit their ideal risk and reward profile.

Risk-averse investors will likely choose profitable companies with a proven track record, while risk seekers will choose junior companies with significant future potential. If their bet pays off and the junior company grows its profits, its share price will likely also increase. At this point, the trader can sell their shares for a gain or hold them to build wealth over the long term.

You must first set up an account with a broker to trade shares. They execute your orders on your behalf. Australia's major banks offer brokerage services, or you can open a trading account with a digital broker. It often pays to shop around as different brokers offer different services and charge different fees.

Before trading, ensure you fully grasp your risk tolerance and investing objectives. This will help you decide which shares to buy and what investing strategy to adopt. It's also a good idea to seek advice from a financial professional, especially if you are a beginner investor.

Some of the main types of shares

There are many different ways to categorise shares. You can divide them by sector or industry, size, geography, or risk or return characteristics. In fact, if you ask three analysts how many categories of shares there are, you will likely get three different answers.

That's a long way of saying that we can't provide an exhaustive list of all the different types of shares out there in this humble article. And you'll likely come across many new ways to categorise shares as you learn more about the stock markets. You might even come up with some categorisations of your own!

However, here are some of the most commonly used terms to get you started on your investing journey.

Blue chip shares

We've already discussed blue-chip stocks a few times in this article. They are typically mature companies with a loyal customer base and a long and dependable track record of success. These companies are often household names with market-leading positions in their industries.

Blue chips will likely pay a handsome dividend, but their share prices might offer little growth potential. However, it's also unlikely that they'll suddenly crash, either.

Dividend shares

As the name suggests, dividend shares pay good, regular, dependable dividends. Many high-dividend shares are blue chips, but they may also be smaller companies that pay a high dividend yield.

This category would likely exclude companies that don't pay consistent dividends or have recently paid high once-off special dividends. Income investors seek out dividend shares with a reputation for paying sustainable, regular dividends.

Growth stocks

We've already touched on growth stocks in this article. These are shares in companies expected to grow much faster than the market average. 

They could be tech shares with an innovative new product in development or a pharmaceutical start-up with a new drug in the clinical trial phase. However, because they are more speculative investments, growth shares also come with higher risks.

Value shares

Value shares are those trading for a price lower than what their underlying fundamentals suggest. They can be distinguished from growth stocks because they are usually more mature, established companies in a good financial position but which have recently suffered a decline in their share price.

The share price decline might be caused by a once-off disappointing result or a nasty piece of market news. However, the share price correction is only expected to be short-term, meaning value investors can profit by buying them at their current bargain prices.

Identifying value shares can be a subjective process – what looks like a bargain to one investor might seem more like a dud to another.

Defensive stocks

Defensive shares tend to preserve their value, even in an economic downturn or a recession. They are usually companies that provide vital products and services that people can't live without. Consequently, they post consistent profits, even when money is tight, and other companies are struggling.

Large-cap

Classifying shares according to size or market capitalisation is also common. Large-cap shares are usually defined as those with a market cap exceeding $10 billion. Knowing a share's market cap can tell you much about its risk because the biggest companies are usually well-established blue chips.

Mid-cap

Mid-cap shares have a market cap between $2 billion and $10 billion. While these are smaller than large-cap shares, many are still part of the S&P/ASX 200 Index (ASX: XJO) (an index of the 200 largest companies on the ASX).

Small-cap

A small-cap share has a market cap of between $250 million and $2 billion. While these are often more risky, junior companies and growth stocks, they can also include some well-known brands.

International

There is a great deal of stock market investment opportunity beyond what the ASX in Australia offers. Many brokers now enable their clients to trade on international markets, especially US markets like the New York Stock Exchange or the tech-heavy NASDAQ.

International shares can include some of the biggest and most profitable companies on the planet. However, investing in shares outside of Australia carries its unique set of risks, notably FX risk if the Australian dollar appreciates against other currencies.

How to use different types of shares to your advantage

As we've discussed, different shares offer different risk and return profiles. Growth shares are high-risk but offer a greater potential return. Blue chips typically pay a good dividend, but their share prices aren't likely to suddenly take off. Defensive shares probably won't light up the market, but you'll be glad you have them in a crisis.

By combining different types of shares, you can construct a diversified portfolio that best suits your personal risk appetite and investing goals. 

You may have a long investing time horizon and can afford to lose a little of your money in the short term in exchange for the possibility of long-term gains. In this case, you'll probably want more of your portfolio invested in growth stocks.

Or maybe you have a medium risk tolerance – the idea of losing some money in the short term makes you a little queasy, but you still want a little risk in your life. In this case, you could balance your growth stocks with blue chips and defensive shares.

Or perhaps you're after some extra income and just want to try and preserve your portfolio's value. You might build a portfolio from dividend shares, blue chips, and other large caps to achieve this goal.

With so many types of stocks, each with different risks and potential payouts, it's possible to create a share portfolio to suit just about any trading strategy.

Building a robust and diversified portfolio

Investing in many types of shares can reduce your portfolio's volatility and ensure you perform well in any market. This is the value that comes from diversifying!

But building a strong, diversified portfolio is a lifelong pursuit. Growing your wealth takes time, and accumulating many different types of shares can be a struggle, especially when starting your investing journey.

However, there is a helpful shortcut to a diversified portfolio. Exchange-traded funds (ETFs) can be a cost-effective and quick way for investors to diversify their holdings. 

ETFs use the money raised from their investors to purchase a diversified portfolio of assets, like shares, bonds or commodities. They are traded on a stock exchange, much like ordinary shares.

There are many different types of ETFs to choose from. Some only invest in small-caps, while others only buy stocks that pay a high dividend yield. Some only invest in international blue-chip shares. And because they trade on the stock market like ordinary shares, investors can gain exposure to a whole basket of different shares in a single trade.

Bear in mind that your ideal share portfolio will change as you age. When you're younger, you can afford to be more of a risk-taker. But as you age, you might be more concerned about preserving your wealth and lowering risk. You might be more interested in supplementing your income with dividend shares in retirement.

This means you should regularly check on your portfolio to ensure it is well-diversified and aligns with your investing goals.

Which type of shares to buy in good times

In a bull market, investors feel positive, company profits are growing, and borrowing costs are low. People are optimistic about the future, which is the ideal environment for growth stocks to flourish.

This means that when times are good, small caps and growth stocks will tend to outperform defensive shares, large caps and blue chips. Not only are people feeling more optimistic, but cashed-up investors will invest in increasingly risky assets when interest rates are low to earn a decent return.

This increase in demand causes the prices of higher-risk assets like growth shares and small caps to rise.

And when times are tough?

On the flip side, when times get tough and the market is bearish, it pays to have a portfolio more weighted towards defensive, blue-chip and large-cap shares. These dependable companies have been through tough times before and survived. Investors trust them and turn to them as safe havens when the economy looks rocky.

When a recession or a downturn hits, it pays to be invested in companies that can generate steady profits throughout the economic lifecycle. These will preserve their value better than growth stocks, small-caps, and other risky assets.