What’s the first thing people should know about investing?
When it comes to being financially responsible, most of us assume having a good chunk of savings behind us will suffice. Experts will tell you there are more gains to be had from investing your money. “You probably already know the main, headline benefit of investing: it offers the possibility of larger returns than you'd get with a savings account,” say the fund experts at AJ Bell Youinvest. “And this, broadly speaking, is backed up by history.”
According to research from Barclays, equities and gilts significantly outperformed cash as an asset between 2008 and 2018, growing in value by 5.8% on average, compared to a 2.5% contraction for cash. “However – and this is a big however – these figures are an average,” warn the AJ Bell experts. “It's crucial to remember that there are no guarantees when investing. Yes, you can make money from the stock market, but you can also lose it – all of it, potentially, if the company you're investing in goes under. It’s precisely because investing can be unpredictable that some people seek the certainty of cash.”
Perhaps it’s better to just save instead?
According to the pros, cash is a less risky asset, but it can lose value over time. “Under the Financial Services Compensation Scheme (FSCS), cash you have in the bank is protected by up to £85,000 per UK-regulated financial institution. But just because your cash is protected by this scheme doesn't mean it's entirely safe from loss,” say those AJ Bell experts. Why? Because of inflation. “If inflation stands at 2% (the Bank of England’s target) and you stick £10,000 in a bank account paying 0% interest, in a year’s time it will be worth £9,800 in real terms. After five years it would have dropped to £9,039 and after ten years to only £8,171. By leaving your money in the bank, you can fall foul of something called 'reckless conservatism'. Your savings might seem safe, but they'll lose value over time if interest rates don't keep up with inflation. And over the last ten years, interest rates have been historically low.”
So what are the main reasons to invest?
According to the investment team at Hargreaves Lansdown, investors have two main motivations:
Investing for income
“Income investors are looking for extra income on top of any existing money they receive. This can be generated from investments that make regular payments, such as shares that pay dividends or bonds that pay interest. Retirees are typically income investors, using the income to supplement any pensions they might receive. Investors should remember that investment income varies and isn’t guaranteed.”
Investing for growth
“The goal for growth investors is to increase the value of the investment itself, known as capital appreciation or a capital gain. In stocks and shares for example, growth is the result of a rise in the price of the shares. Someone who has just started their first job and joined a pension scheme might be a growth investor. They are likely to hold their investments for a long time and are hoping to grow the overall value of their investments.”
In reality, most investors will combine these two strategies. For example, an income investor might reinvest that income, while a growth investor might gradually sell their holdings to generate income.
Is it possible to manage the risk when you invest?
The potential for greater upside is precisely why some people plump for investing over saving – it means your wealth can outgrow the effects of inflation. But it’s a trade-off. “You might make more money than saving, but you also have to accept the possibility you might lose more money, too,” warn the AJ Bell Youinvest advisors. But, they add, it’s a mistake to view investing as nothing but a high-stakes gamble. “You can curb the risk you take on in several ways. One is by investing over the long term, i.e. five years or more. A longer timeframe gives your money more time to bounce back in case there’s a market downturn. Another way is by diversifying – that is, not putting your eggs in one basket. If you invest in only one sector or company and it goes south, your entire portfolio will be dragged with it.” It’s also important to remember different investments carry different levels of risk. “If you wanted to take it cautiously, for example, you could choose bonds instead of shares, or leave it to an expert by buying into a fund.”
What can you invest in?
The answer, in short, is virtually anything. As far as financial markets go, it usually comes down to stocks, bonds and funds. The AJ Bell Youinvest experts explain:
“A fund is a collection of investments, chosen and managed by an expert – usually for a fee. There are many different types of fund, including OEICs, ETFs and investment trusts. As a typical fund contains many different investments, it's a handy way to diversify where your money is – with just one investment. And as the selection is chosen and managed by a fund manager, you can leave the hard work of picking individual investments to an expert.”
“When you buy a share (also known as a stock or equity), you buy a tiny part of a company. If the company does well, so will your investment. And you may receive a proportion of the profits (called a dividend). Historically, shares have outperformed safer investments like cash and bonds. But they're also riskier. It takes research to find companies worth investing in, and you'll need to consider buying a diverse range of shares, so your eggs aren’t in one basket.”
“Bonds are a bit like IOUs. When you buy a bond, you're effectively lending a company or government money. You also receive interest – the higher the risk of the bond, the more interest you'll get. Bonds issued by the UK government are called gilts. Bonds are seen as less risky than shares, and compared to stock markets, bond markets tend to be less volatile. But, historically, bonds have offered lower returns over the long term.”
How much should you invest?
It shouldn’t come as a huge surprise to hear there's no one-size-fits-all answer to this question. “It depends on how much you can afford,” say the AJ Bell Youinvest experts. “And secondly, it depends on your goals. What are you saving for, and when? This will give you a rough idea of how much you need to put in every month, or every year, to hit your target.” Another important variable is your rate of return. “Knowing exactly how your investments will fare in the future is impossible. But to get an idea, you can let history be your guide. The average annual return on UK investments between 1989 and 2014, adjusted for inflation, was 5.2% for shares, 4.6% for bonds and -0.8% for cash. Just remember, however, that this is just an average, and how the market has performed in the past isn’t a perfect gauge for how it'll do in the future.”
Is now the right time to start investing?
Markets go up and down, so it’s more important to understand your personal circumstances, and whether there’s enough headroom in your own finances to start investing. “Investing your money, rather than using it to pay down any high-interest loans (e.g. credit cards) can be a costly mistake,” suggest the AJ Bell Youinvest team. “If the APR on your loan exceeds the average annual return on shares for UK investors of 5.2%, it’s sensible to pay the loan off first.”
Money you invest in the markets won't be available to meet any bills, everyday expenses or spending commitments such as upcoming holidays either. “Before you begin investing, make sure you’ve planned out your finances and set aside enough cash to afford your outgoings,” say the AJ Bell Youinvest advisors. “Broken boilers, leaky roofs, losing your job – life is full of unexpected expenses. So, as well as setting aside money to tackle everyday outgoings, it can be a good idea to keep a cash cushion to the tune of a few months' salary to tide you over for when the gods don’t smile on you.”
Is it always best to invest for the long term?
Investment enthusiasts often quote long-standing wisdom that if you hold onto an asset – whether it be shares, a position in a fund or even a house – the value is likely to go up the longer you stick with it. “The longer you invest for, the more likely it is your patience will be rewarded with profit,” agree the AJ Bell Youinvest team. “But when investing, there are no guarantees. A good guiding principle is: only invest money you can afford to lose. If the mere thought of taking a risk with your wealth puts you in a sweat, it’s probably better to give investing a swerve.”
Okay, so how do you actually start doing this?
Investments can be bought and sold online, through mobile apps, over the phone and by post. But it’s still done through stockbrokers and fund supermarkets, who usually offer three levels of service, as the Hargreaves Lansdown team explain:
“Execution-only is DIY investing. Investors make their own investment decisions and place instructions with a broker, often online, who will then ‘execute’ those instructions. This way of investing usually has the lowest costs.”
“An advisory service offers advice from a financial expert based upon your personal circumstances, attitude to investment risk and financial goals.”
“Discretionary management means leaving the management of your investments to the experts, with all investment decisions being made on your behalf. Discretionary management is suitable for those with larger portfolios and limited time or expertise.”
*DISCLAIMER: Anything written by SheerLuxe is not intended to constitute financial advice. The views expressed in this article reflect the opinions of the individuals, not the company. Always consult with an independent financial advisor or expert before making an investment or personal finance decisions.
DISCLAIMER: We endeavour to always credit the correct original source of every image we use. If you think a credit may be incorrect, please contact us at [email protected].