Introduction to Investing

Overview

There are a number of steps we can take to achieve a state of financial well-being. These include:

  • Planning and budgeting
  • Managing debt
  • Personal protection (insurance)
  • Saving and investing
  • Tax efficiency
  • Planning for retirement

Here we try to demystify and explain the basic concepts of saving and investing.

Index

Introduction

Investing can be intimidating but it doesn’t have to be.

On this website, we will go through the basics with you. We will cut through the financial jargon by simplifying technical terms into more accessible lingo so you can consider investing. Ideally, we should all be investing more for retirement or life’s sudden surprises.

This guide will encourage you to get started and build your confidence to invest more. The basics are really quite simple.

First, make sure that the costs and expenses that you incur are as low as possible. In fact, some say this is rule number one, two and three.

We want to make sure your investments are diversified so that your eggs are not all in one basket. This is often referred to as the only free lunch in investing. We will help you achieve this goal in a later section.

And finally, don’t let losses mount. Don’t forget it takes a 100% profit to recover from a 50% loss and 100% profits don’t occur that often!

What is investing?

Simply put - money can make you more money.

There are two principal ways to invest and increase your wealth.

The first is when your investment is guaranteed and can’t be lost, such as a savings account or even a premium bond. However, the return on these ‘risk free’ investments are understandably lower relative to the second way to invest which is where your money is potentially at risk of loss, such as an investment in the stock market.

For example, property has been a great investment for many years in the UK, though if the property is not your primary residence, it might take a lot of time and effort to manage and so is not suitable for all and of course depends on your investment time horizon.

An investment return can come from many weird and wonderful places. Remember the tulip bubble in Holland in the 17th century? Classic cars, art or stamp collections or indeed any asset where someone will pay more than you paid over time are all options.

However, these investments typically require specialist knowledge and can suffer from a wide difference between what a buyer will pay and what a seller would like to receive known as the difference between the bid and offer.

Most investors seeking to gain a return on their money in excess of the general savings rate opt for an investment in the financial markets. The primary advantage is that such investments are typically highly liquid and so can be bought or sold within minutes.

So, let’s get started.

The importance of minimising investment expenses

Minimising expenses is the single most important action an investor can take.

Fees and expenses typically compound over the duration of your investment and can eat away as much as 50% of everything you make.

There are two principle forms of expense: the ongoing charge of the actual fund and the fee charged by your account holder, sometimes called a platform charge.

As a general rule, the combined total of these two fees should not exceed 0.5% per annum.

Achieving this low level of combined fees will usually require using low cost Exchange Traded Funds (ETFs) as your investment vehicle because actively managed mutual funds typically charge around 0.65% per annum together with the associated platform fee.

Types of product to invest in

Let us now consider the most common form of investments.

Most investors choose to invest in a fund of which there are various types.

Common to all funds is that they pool all of their investors' money and then invest in a range of assets depending on the specified investment objective.

The principal differentiating factor is their management style. Mutual funds and Investment trusts are what are known as actively managed, in that the investment decisions are made by a manager.

ETFs and index funds are designed to track a specific index without active management and as a result are frequently less expensive.

The debate rages between active and passive management style but most analysts generally agree that active managers do not outperform passive investments, thus the increasing popularity of passive investments or ETFs which now account for 50% of all new investments made in the US.

Building a portfolio

Typically, a portfolio will have an allocation to the stock market, the bond market and a smaller allocation to alternatives such as gold, commodities and property.

The longer your investment time horizon, the greater will be the allocation to stocks which are considered to be riskier than bonds but which also have a higher expected return over the long term.

The closer you are to retirement, the greater will be the allocation to bonds.

Within these - what are known as asset classes - there are further options which help us to build a diversified portfolio.

  • equities - exposure to UK, USA, Europe, Asia and Japan
  • bonds - government and corporate
  • alternatives - gold, commodities and property

The power of compounding returns

Albert Einstein called compound interest the “most powerful force in the universe,” and to understand the basics of compounding you don’t have to be genius like Einstein.

The concept is a little like a snowball effect. Think as a snowball rolls down a hill it will gather snowflakes and becomes bigger and bigger, just like that your capital can grow too. So, earning interest on your interest is the concept of compounding.

Obviously, the sooner you start regular investing, the greater can be the effect on the eventual outcome of compound returns.

The benefit of regular (monthly) saving

To safeguard your future, investing is an integral part of financial planning. There are many advantages when it comes to saving on a monthly basis.

First of all, figure out how much you can afford to put away and for how long. You can then build up a lump sum of money for a particular purpose such as retirement, a new home or your children’s future. See how regular saving can make such a big difference by using our Regular Saving tool.

Know yourself

Before making any investment decisions try to figure out your risk appetite.

Markets are frequently volatile in the short term and if you can’t sleep at night from worrying about your investments, then you have probably taken on too much risk.

Are you a low risk investor? How much risk are you comfortable with?

Someone approaching retirement will have a very different and typically lower risk appetite than someone just starting out into work.

But someone just starting into work maybe focused on saving for the deposit for a house and so can’t afford to take much risk.

What is your long-term investment goal? Any financial plan will consider the bigger picture.

A number of advisers suggest putting aside 10% of your net income per pay check when you’re in your 20s for long-term goals like retirement. And if you start when you are young you will have the power of compounding on your side.

The point here is that an investment is not the same for all people. There is no right or wrong answer. The key is that you are saving in one form or another.

Market downturns

During the greatest market downturns we may find the greatest investment opportunities. A stock market crash is usually rapid and often unanticipated, the result of a major catastrophic event, economic crisis or the collapse of a long-term speculative bubble.

However, public panic is also a major contributor. During a downturn we find people scrambling to sell their stocks and other assets all at the same time due to economic turmoil and this exacerbates market instability.

Depending on your investment time horizon, this might be an opportunity to buy some cheaper investments but it might also make sense to reduce your exposure if you will need access to your funds within a few years.

Market downturns will happen and they are one reason why diversification is important. Equity markets around the world are quite inter-related which is why an allocation to bonds and alternatives may help to preserve your capital.

Portfolios and diversification

When it comes to investing, it is important to spread your wealth. Diversifying your assets is the practice of spreading your investments in order to reduce the volatility of your portfolio over time. It is extremely important not to put all your eggs in one basket.

As a result, it makes sense to invest in as many of the asset classes and the options they contain as possible including bonds and alternative investments.

Many financial advisors normally recommend a portfolio made up of some 10 to 15 different allocations.

Many consider gold to be a defensive allocation in that it has historically been considered as a ‘safe haven’ when everything else is uncertain.

About investing - conclusion

The investment landscape is changing rapidly with more and more products being introduced to the UK market.

It has never been a more fascinating time in the world of investments. We will do our best to simplify investments and get you on the right track.

The value of investments can fall as well as rise and any income from them is not guaranteed and you may get back less than you invested. Past performance is not a guide to future performance. Read more