A new year feels like a fresh start, and it’s a great time to get a better handle on your money especially if, like many, you felt financial pressures during a challenging 2020.
If you’re ready to make your money work harder this year, why not start investing? Part one of our two-part guide walks you through the key things you need to know.
What is investing?
Quite simply, the aim of investing is to grow your money over time. Most novice investors try to do this by investing in the stock markets, which are exchanges where you can buy and sell shares in many different companies. Buying a fund lets you hold lots of shares at once, without having to do the trading yourself (more on funds in below).
Who is investing for?
There’s a perception that only the wealthiest people invest, but really investing is for everyone. Investing platforms have democratised the process and opened up the investment world to beginners with just a little spare cash. Although you don’t have to be wealthy to invest, it is a good idea to wait until you have a little financial stability first, because with investing there’s a chance you can lose money.
If you have debts (not including a mortgage), it’s wise to pay these off before you start dabbling in stock markets, because they could cost you more in interest than you might get in investment returns. You should also have an easily accessible cash emergency fund in place equal to three to six months’ living expenses. Once you’ve ticked these two boxes, investing could be a good next step towards building your future financial security.
What can I invest in? Asset classes explained
An ‘asset class’ just means a type of investment in which you can put your money. The main ones are shares (also called stocks or equities), bonds, property, commodities and cash.
When you buy shares, the company uses your capital to grow, and in exchange you own a tiny slice of that business. Some types of shares give you a say in how the company is run.
When you buy bonds, you lend money to a company or government on the understanding that it will be repaid at the end of the term (when the bond ‘matures’), with interest paid to you along the way. Because of this, bonds are often seen as lower risk than shares.
Property includes physical buildings as well as shares in listed property companies, while commodities include things like precious metals, crude oil, natural gas, and grains. Cash isn’t an investment as such, but most investors will keep some cash in their portfolios ready to buy new investments when they see opportunities, or they might hold more in cash and have less money invested when stock markets are falling.
What are the risks?
When you invest, your money is at risk. That means you could end up with less money than you started with, and you could even lose everything. There’s no predicting what the stock market will do, and your investments might not perform as you expect. That’s why it’s important not to take on a higher level of risk than you are comfortable with, and to invest for the long term – at least five years ideally. This gives you a chance to recoup any losses over time.
Another important way to reduce risk is to have an investment portfolio (a portfolio is just a collection of different investments) that’s balanced. The experts normally recommend you hold a mix of stocks and bonds, as well as alternatives (such as property and commodities) and cash. The idea of this is to spread your risk – when you hold a few different types of investments, there’s a better chance that they won’t all fall in value at the same time. For more information on investing risk, read our guide here.
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How much could I make?
Investing puts your capital at risk – which means you may end up with less than you started with. However, there’s also a big opportunity cost from only saving in cash. For example, the MSCI World returned 9.87% a year annualised over the 10 years from 31 December 2010 to 31 December 2020, so let’s call that a 10% annual return.*
According to this calculator, £10,000 invested at that rate of return 10 years ago would be worth £26,495 today. Not bad. But what if you saved that money in cash instead? You usually get a better rate on your savings if you can afford to lock them away for a while. In December 2020, the average rate on a five-year fixed-term savings bond was 0.97% according to Moneyfacts. So £10,000 saved over 10 years at that rate per year would have made you £11,013. That’s more than £15,000 less (although we should note that with cash savings there are no jumps in the ride and you get steady and predictable growth, with no risk of loss).
It’s impossible to say what sort of return you will get from your investments, because value can go down as well as up, there are no guarantees and no-one has a crystal ball. However, we can get some perspective by looking at the very long-term performance of stock markets. The FTSE 100 is the UK’s main stock market, made up of the 100 largest listed companies. Its average return was 7.75% a year between 30 December 1983 and 31 December 2019. That’s an average though – bear in mind there will be years when everything falls, and big swings up and down in between.**
* Bear in mind though that this return is in US dollars, so there might be some currency fluctuations in converting it to the equivalent sterling return.
** Past performance isn’t a reliable indicator of future results. It’s also important to note that fees and charges can have a drag effect on performance, so how much you are paying for your investments will impact your returns.
How much should I invest?
Don’t invest more than you can afford to lose, even if that means starting small. Many investment platforms will allow you to invest from £25 a month, and some from £10. Putting money in regularly is more important than the amount you put in. That’s because the stock market rises and falls, and the value of the shares you hold goes up and down. By drip-feeding money every month, you buy shares at different prices over time, and this can even out your returns in the long run.
You get the most benefit from investing the earlier you start. That’s because of something magical called compound interest. Essentially, this is when your money makes money, and then that money makes money too, and so on, like a snowball rolling downhill. By earning interest on the interest, your total savings pot can ramp up really quickly.
How do I actually invest?
Back in the day, a suited and booted stockbroker might have made your trades for you, but nowadays you can do it yourself. Anyone can buy shares or funds on investment platforms like online stockbrokers or fund supermarkets, and it’s usually a cheaper way to do it, although you can often also buy funds directly from the provider, that is the asset manager whose brand is on the fund.
Which platform you choose will depend on what matters to you – do you want the lowest fees and charges, the widest range of investments to choose from, lots of free guides and research, or a user-friendly website and app? You can compare investing platforms on price comparison sites to find the best fit.
Once you’ve signed up to a platform, you will usually have the choice to open a general investment account or a Stocks & Shares ISA. The latter is a good choice for most people as ISAs protect your money from tax. In your ISA you can hold a mix of shares, funds and other things, and you can put in up to £20,000 each tax year*.
When you’ve chosen your account type, you can fund it with a lump sum, or set up a regular savings plan to put an amount in each month. Now you need to choose your investments.
*Tax treatment depends on your individual circumstances and may be subject to change in the future
Shares vs funds
So what should you put in your investment portfolio? While a lot of investors start out by buying shares in individual companies, such as their employer if there’s a discounted share scheme in place, or shares in brands they are familiar with, buying shares is quite a high-risk strategy. Most beginner investors would probably find it more straightforward to buy a fund. What’s the difference? When you buy a fund, you pool your money with lots of other investors, and a professional fund manager oversees all the investment decisions on your behalf. So you end up holding lots of different shares at once, which should spread your risk – if you hold shares in 100 companies and 10 of those fall in value, you’ve still got 90 that might be doing well.
There are lots of different funds doing lots of different things, but they will all have some kind of theme, such as geography, asset class, sector, company size or investment style. Just holding one or two broad-based funds such as a global equity fund or a multi-asset fund which includes lots of different asset types could be enough to give you a diversified portfolio.
While you pay a fund management charge to the asset manager who runs the fund, it still works out much cheaper than the cost of buying and selling individual shares – some platforms can charge £8-£12 per trade for this.
DIY vs managed
Not everyone wants to pick and manage their own investments though. That’s why a managed service like those offered by a digital wealth manager can be a good option for novice investors. You’ll be asked to take a risk questionnaire to work out whether you’re more of a cautious or an adventurous investor. The platform will then suggest a portfolio for you with a handful of funds or other underlying investments like shares and bonds already picked. You may be given different options to choose from, such as ethical or socially responsible portfolios.
Digital wealth managers will often keep costs down by using passive funds (such as index funds or exchange-traded funds – ETFs) in their ready-built portfolios. These are cheap, no-frills funds which track the performance of stock markets using computer algorithms rather than an actual human making the decisions. Most mainstream investment platforms will offer some options like ready-made Stocks & Shares ISAs or off-the-peg investment portfolios that you can select according to their risk level. You’ll pay a management fee to the platform to run the portfolio, making changes as needed so that it stays in line with your appetite for risk.
Start by researching and choosing your investment platform, and from there you can decide whether to build your own portfolio or buy a ready-made one. Want to choose your own investments but don’t know where to begin? Do some research on the investment platform – most will have free resources, helpful guides and recommended funds lists that can help you narrow down the options. Think about how much you can really afford to invest, then set up a regular automatic payment to fund your investing account and that’s it, you’re an investor.
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We built ikigai specifically for those who want to bring their lifestyle to the next level, by taking better care of their finances.
ikigai beautifully combines wealth management and everyday banking in one single app. And by doing so, it creates a whole new world of opportunities.
Visit https://ikigai.money to find out more.Maurizio & Edgar, Co-Founders, ikigai
When investing, your capital is at risk.