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What exactly is investing?
Investing is much simpler than you might think. In a nutshell, when you invest, you’re simply buying something now which you think will be worth more in the future. That’s it. This beginners guide to investing will walk you through your options.
Why should I invest rather than saving my money?
The reason that many of us prefer to save our money is because we know it will still be there when we need it. This logic is what deters many beginners from investing, the risk that we will lose some or all of our cash. Some would argue that saving is a sensible approach to looking after your money but if you take inflation into account, you’ll see that you’re actually getting nowhere fast.
Is there a chance I could lose all my money?
As a beginner you should find a balance between investment risk and any potential reward. Generally, the more cautious your approach the less likely you are to make significant gains. Remember what we said above about savings? The opposite is also true.
If you take too many risks, you increase the chances of losing some or all of your money. This is a very simplified overview of the relationship between risk and return but there are some effective ways that this risk can be managed and reduced.
3 simple ways to manage risk when investing your money.
Having all your eggs in one basket increases the risk. If you divide your money between multiple investments, you’re less exposed if one of those investments fails. This is known as diversification and is one of the best ways to protect your investment pot.
You should also invest for the long term. For various reasons the value of investments will naturally rise and fall over time but if you’re able to ride this out you stand a better chance of making a good return in the end. If you need to access your money in the short term (less than 5 years) then investing might not be the right option.
Finally, making smaller regular investments rather than a larger lump sum also decreases the risk. By investing in this way you’re essentially buying at the average price over a period of time. This will protect you from price fluctuations or market volatility.
How to set realistic investment goals.
You need to have a plan which takes into account where you’re starting from, your budget and where you want to get to. This means you should have a detailed understanding of your personal finances. Budgeting for regular investments is essential as opposed to just investing what’s left at the end of the month.
Also, the earlier you start the better as you’ll have a lot more time to ride out any fluctuations in the market. Starting early also allows you to be a little more aggressive, potentially increasing your gains. You’ll also benefit from the effects of compounding over a longer period. Compounding is basically gains on top of gains. Your money snowballs over time.
So how do I actually invest my money?
Firstly, you’ll need to choose an investment platform and open an account. Finding a good platform takes a little research but you should be asking yourself the following questions.
- Does the platform have a good mobile app? This is essential if you’re the kind of person who likes to keep an eye on things while you’re on the go.
- What are the account fees and how do these compare to other platforms? There are a number of charges you need to consider ranging from general annual account management fees and dealing fees. Dealing fees are charged by the platform on most transactions – buy or sell.
- Does the platform offer a wide range of investments? Some platforms have a much larger range of products available which is an obvious advantage for diversification of your portfolio. Some platforms also do the research for you and offer readymade investment portfolios to suit your needs.
- Does the platform offer the type of investment account you want? Self-invested stocks and shares ISAs, Lifetime ISAs or Self-invested Personal Pensions? You should research what account best suits your needs and goals. There are also tax implications and benefits which differ across the various options.
- Do they provide good customer service? The benefits of good customer service are obvious particularly if you a beginner needing some support.
Once you’re set up you need to deposit some money into your account to get you started. Your money will sit there as a cash balance until you decide where you’d like to invest it. The most common investment types are outlined below.
What are the different types of investments?
Shares – also known as stocks or equities.
If a particular company needs to generate some cash for expansion or new facilities, then it has a couple of options. The first is to borrow from the banks and keep full ownership of the company. The second is to break the company up into lots of small pieces and sell them to investors on the stock market. Selling shares dilutes ownership of the company amongst many investors, however the company avoids the repayments and interest associated with borrowing.
The value of these shares will increase if company continues to do well but can also fall if the company performs badly. Finding the right shares to invest in takes quite a lot of work and carries a greater risk.
Potential investors must take account of the company’s finances as well as a host of other economic factors which can affect the performance of their shares. Fear not though, shares aren’t the only option available to you as an investor.
Bonds
Bonds are issued by governments and corporations. Government bonds are known as Gilts in the UK. Essentially if you invest in bonds, you are lending your money to the issuer of the bond. Depending on the terms of the bond, the issuer agrees to pay you a set rate of interest until the maturity date when the loan is repaid in full.
Bonds and gilts are generally seen as low risk investments which provide a predictable income over a set period of time. The overall return therefore may be much less than those from shares and can be drastically reduced by rising inflation.
Funds
A fund is a large pool of many investors money which is used to purchase a broad mixture of shares, bonds and other asset types. The proportion of the pool which is allocated to each asset type depends on the investment philosophy and goals of each individual fund.
More adventurous funds might hold mainly shares while lower risk funds hold less shares and more fixed return assets such as gilts and bonds. In addition, funds may specialise in a particular industry or country.
A fund might target Growth, in other words investments whose value has the potential rise quickly. Others look for Value i.e. investments which they feel are currently under-priced while others may target investments which provide regular Income in the form of dividends.
Active funds employ fund managers who are responsible for making decisions about where to put your money. Passive funds are those that are designed to mimic a particular share index such as the FTSE 100. This index consists of the top 100 largest UK companies.
A FTSE 100 index tracker fund might just invest in every one of the 100 companies listed. Whilst index trackers by definition are unlikely to beat the market in terms of returns, they come with much lower fees because they take less time and effort to manage.
The beauty of funds is that you’re able to create a diverse investment portfolio, spreading your risk whilst avoiding the fees which would be incurred trying to buy a number of different assets yourself. Another advantage is that there are literally thousands of different funds to choose from to build your ideal portfolio.
Investment Trusts
Trusts are very similar to funds in that they also consist of a pool of investors’ money however there are some key differences to take into account which could give them the edge over many funds.
Funds are open-ended which means that as more people invest, more units are created. Investment trusts are closed-ended. Why does this matter? You can only buy shares in the fund if someone wants to sell, the number of shares is fixed.
The result is that the trust manager can be more focussed on the objective of the trust rather than having the constant pressure to buy and sell assets as people invest and withdraw their money from a fund.
In addition, investment trusts are able to borrow money to invest. This is known as “gearing” and can potentially increase returns. The downside is that this borrowing comes with risk.
How much of my money should I invest?
This really depends on your starting point and your goals. Common advice is to half your age and invest that as a percentage of your income so if your 30 years old you should aim to invest 15% of your income each month.
For many this may seem like a very large portion of your income particularly given the current squeeze on the cost of living. At the end of the day, you’re the only person that can decide what is right for your situation.
Conclusions
Taking control of your finances and investing for the future can be both empowering and rewarding. Every investment carries risk but hopefully you’ll see that it’s not all black and white, there is a middle ground where good returns can be achieved without excessive risk. Hopefully this beginners guide to investing has helped make sense of the options available and helps you take your first steps.
With a little effort and attention to detail your money could be working for you. Eventually you might find you don’t have to work so hard yourself!
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