Stock Market: Just like a roller-coaster, only it's not a game

Millions of people are discovering the joys and agonies of share ownership following the demutualisation of building societies and insurers, including Halifax, Alliance & Leicester, Woolwich, Norwich Union and, next week, Northern Rock. In the first of a regular series, John Andrew explains the mysteries of the stock market. One of the quirkiest brochures promoting a stock market investment was titled "Why You Should Consider An Investment Where You Could Lose Money".

Of course, we are all familiar with so-called wealth warnings - the price of shares can go down as well as up and may fall below the amount originally invested. One may well ask: if it is possible to lose money on the stock market, why bother to invest?

Simply because by taking the risk of investing in shares instead of a savings account there is the greater potential to make money. As Tony Hobman of ProShare, an organisation which promotes share ownership, points out: "Investing in the stock market is one of the best ways of building up capital."

Historically the stock market has given investors a better return than savings accounts. On the radio and TV news and in newspapers, reference is frequently made to the Financial Times Stock Exchange 100 Share Index, or FTSE 100, affectionately known as the Footsie. It is an index that measures the price movement of the leading 100 UK companies' shares listed on the London Stock Exchange. It started life on 3 January 1984 with a base of 1,000. When the Footsie broke the 5,000 level on 6 August 1997, it meant the index had risen by a multiple of five since 1984.

A better way of expressing this potential for growth is to compare the performance of pounds 1,000 invested in Footsie shares against the same amount placed in an average building society savings account over the 10 years to 1 September. Save & Prosper, the fund management firm, calculates that for interest rates paid on deposits below pounds 2,500, the pounds 1,000 investment would have grown to pounds 1,673.48. By contrast, the Footsie would have delivered pounds 2,141.11 over the same period.

These figures assume the net income in the savings account has been reinvested. By contrast, the stock market performance is based entirely on the price movement of the shares and ignores the income, known as dividends, paid to shareholders. Bear in mind too that the above figures include the 1987 stock market crash. Equally, the charges for buying and selling the shares have been ignored.

The stock market wins hands down. However, data such as this can lead to complacency. You must remember that the past performance of the stock market is no guarantee for the future. Also, although the price of shares moves up and down, the prices of individual shares do not move in unison.

Some companies' shares perform better than others, some worse and a few even fail. Two of the original top 100 companies represented by Footsie in 1984 have gone bust, their shareholders losing all their investment. So, when you see the standard warning in investment advertisements, it is a message that is meant to be taken seriously.

This is why you should not contemplate putting a lump sum into an investment related to the stock market unless you have a comfort level of savings. Keep money for emergencies in an instant access account and further reserves in a notice account for a higher rate of interest.

Although traditional savings accounts are safe, in the sense that your money does not fluctuate in value, there is nevertheless the risk of erosion by inflation. It is important to protect your purchasing power. In fact, over the past 10 years the stock market not only outperformed the savings account but also comfortably beat the Retail Price Index, the main measure of inflation. This means that over the past 10 years, the value of the shares will buy more goods than the sum originally invested and more than the same placed in a savings account.

Of course, the stock market is not without risk, but let us put this into perspective. The worst day for the world's stock markets was 19 October 1987, which is commonly referred to as Black Monday. Share prices on Wall Street plunged by nearly 25 per cent, while in London they fell 11 per cent. By 9 November 1987, the Footsie was down 32 per cent. Such falls really bring home the risk of stock market investment. However, 21 months later, the Footsie was back to its pre-crash level. Investors with shares in sound companies saw the value of their shares restored in time.

Those who bought in July 1987, when the market was at its year's high, had to wait nearly five years before they saw their holdings worth substantially more. This is why stock market investments have to be viewed as a medium to long-term commitment - that is for at least five years.

`Investing in the Stock Market', by ProShare, is available by sending an A4 stamped addressed envelope to: ProShare, 13-14 Basinghall Street, London, EC2V 5BQ