A beginner’s guide to investing article is a guest post from Financial Expert.
In a world with historically low interest rates, British savers are experiencing a difficult time.
At the date of writing, the highest interest rate on offer is 2.25% on a five year savings account.
At the moment, the inflation rate stands at 1.7%. This means that the cost of living is rising at almost the same rate as savings are. If you earn less than 1.7% on your own savings, this is very bad news. It means that your savings balance will buy you fewer goods and services after one year compared to the present!
This topsy turvy situation – where savers can lose buying power over time, is not new and is likely to continue for some time due to the lacklustre performance of the economy.
This is leading savers to turn to riskier investments, such as stocks and shares, in search of a real return that will see their savings reward them over time. Lets have a look in abeginners guide to investing at how this can all be made clear.
A beginner’s guide to investing in 6 steps
Therefore, I’ve pulled together a beginners guide to investing. One article will never be able to capture all the complexities of investing your money. What this guide will do is highlight what you’ll want to understand before you ‘upgrade’ your savings approach.
Step 1: Understand your time horizon and which investments match yours
Investments such as stocks and shares, corporate bonds, VCT investments and property are long term investments. This is the case because:
- You pay fees to enter and exit them. If you only invest for a short period of time, these will eat away much of your return.
- You can research the ‘average expected return’ of an investment, based on its past performance. However, in the short term, nobody can reliably predict whether an investment will return more or less than this prediction. The law of averages means that over longer periods the return will get closer and closer to that average though. Therefore the overall risk of an investment disappointing you is reduced greatly by holding it for a long period of time.
- Your return from an investment is only set in stone when you sell your stake and receive cash. If you can avoid touching your investments, you will never be forced to sell them for a low price during a temporary market downturn. Investors who can hold onto investments for the long term can weather such storms and sell at a more favourable time.
Because of the reasons above, you should only invest with money you can ‘lock away’ for at least 5 – 10 years.
This makes investments a popular vehicle for retirement savings. They are less likely to be used for shorter-term goals such as saving for a house deposit.
This might feel like the least exciting step in this – a beginners guide to investing – but it actually is the most important. Investing in shares without enough time to wait for them to perform well, is closer to gambling than saving.
Step 2: Get to know your risk appetite
Your risk appetite is a measure of how comfortable with the risk of losing some of your money.
Investments like stocks and shares bring plenty of uncertainty. You cannot be sure that they will deliver a positive return, and you may even incur a loss for an extended length of time.
When your investments are performing poorly, it can be easy to let this affect your mood. Despite making the investment with the right intentions, you may still begin to regret your decision and see it as a ‘mistake’ with hindsight.
On the other hand, many people are able to stomach losses easily and are able to block out the bleak news until things turn around. Such folk are naturally built to hold investments, as they are less likely to be affected by the swings of the stock market.
It can be difficult to place yourself in either one of these camps, although there are many questionnaires available online to give you an indication of whether you have a high-risk tolerance or not.
Risk appetite can increase over time, with experience. When I made my first investment at the age of 21, I remember logging into my account on a daily basis to check up on its performance, anxious that it was in the green and not the red. Now, at the age of 30, I check only once a month and can shrug off a disappointing number.
Being cautious with money does confine you to a bank account for life. Investments come in many varieties, and some are designed with cautious investors in mind. They contain fewer shares and more bonds and may be described as ‘medium risk’ rather than ‘high risk’ resulting in a much smoother ride overall.
Step 3: Choose a stockbroker
You are probably already the customer of a stockbroker: most major UK banks are happy to offer investment accounts to their customers. However, banks rarely offer the best value for their services. A whole array of specialist companies exist to serve investors.
Investment accounts go by many names; ‘Share dealing service’ ‘Full-service stockbroking’ or even ‘Investment platform’. Regardless of the name, these will all allow you to place your money in a wide range of investments. These usually come in two forms:
- Shares of individual companies
- Collective investment schemes, known as ‘funds’, which pool your money alongside other investors and hire a professional money manager to make investment decisions on your behalf.
Stockbrokers charge an annual account fee, and a fee for each buy or sell order you give them. Some providers charge a fixed price for these services, while others charge a % of the account or trade value. Shop around widely to see which provider will be the cheapest for you. This is a key stratergy in a beginners guide to investing.
Step 4: Choose an asset allocation
The time has come to decide what investments you will make.
Beginners usually allocate their money between the following ‘asset classes’:
- Shares – Partial ownership of a company, and entitlement to a share of its profits
- Bonds – Ownership of a loan made to a company or government, with entitlement to repayment plus interest.
The size of the allocation to shares will determine how volatile and risky the overall investment account will be, as it is the higher risk element.
Bonds offer lower returns but act as ‘stablisers’. They pay a more consistent income and have steadier valuations compared to shares.
Young investors, with a long time horizon may be comfortable allocating 80% to shares and 20% to bonds.
In contrast, a 60-year-old anticipating retirement may only decide to allocate 40% to shares and 60% to bonds.
A retiree might actually decide that they have a long time horizon. After all, a retirement fund is not necessarily emptied on day one of retirement. At least some part may not be touched for twenty years. However, losing an employment income tends to reduce ones appetite for risk. The prospect of a loss feels more significant when you no longer have the means to earn further income. So we tend to see that the allocation to shares falls with age.
An old rule of thumb is to subtract your age from 100, and this gives the % that you should allocate to shares. There’s no science behind this rule, but it generally encourages a reduction of exposure to shares dependent on age.
Step 5: Pick your investments
Oh this is the most fun thing to do when working through a beginners guide to investing
Once you have made an asset allocation decision, it is time to pick individual investments which reflect this strategy.
When beginning, I advise you to keep your portfolio simple. This will keep the number of investment decisions, and fees, to a minimum. Minimising fees paid is, of course, always a plus if you want to hang onto as much of your cash as possible.
The simplest approach is to choose a fund which invests in a broad range of UK or global shares, and a fund that invests in a broad range of bonds.
There are at least 100 popular funds that invest in the large UK or international companies and bonds, therefore it can be difficult to narrow down the list.
As an echo of the above, my suggestion is to look for funds with low fees (known as ongoing management charges). Management charges are the fees that the fund manager deducts from the fund’s holdings each year to cover their salary etc.
Management charges can be as low as 0.08%, and as high as 2%, therefore shopping around can yield some serious savings. Brands of funds which tend to have the lowest charges in the industry include:
- Blackrock iShares; and
So looking at these providers wouldn’t be a bad place to start.
If after performing research you still feel lost at this stage, you might want to consider engaging with an independent financial adviser. This can provide piece-of-mind that you have taken the right level of risk for your appetite, but the advice won’t come cheap. A consultation with actionable advice will likely cost no less than £1,000. Therefore if you are investing only a small sum, this may not be an economical option.
Step 6: Execute a trade
A beginners guide to investing would not be complete without the final step of asking your stockbroker to purchase the funds you desire.
All stockbrokers operate with online trading systems, therefore the process of buying is quick and easy.
To complete the online form to buy a share or a fund, you will need to know the following:
- The name of the fund or company
- How much in pounds that you would like to spend
- When you want the trade to happen
That’s all. Once you have submitted the request, you will be provided with a quote screen which provides you with information such as:
- The number of shares or units that your money will buy
- The total cost of the trade
- Any trading fees included in the price
Check the information and click confirm to give your broker the instruction to buy. The transaction may take up to 3 working days to completely process, although you will usually see the cash leave your account balance immediately.
Happy researching – A Beginners Guide to Investing
This guide only provides a high-level guide to investing. Please perform your own research on any investments you plan to make, and consider seeking independent professional financial advice if your circumstances are complex or you do not feel confident.
There are plenty of resources available online that will provide further education on all of these areas. I recommend that you study these areas before proceeding further.
Average investors can earn a return of up to 6% per year, which for many, makes the risk of investing in shares very worthwhile.
I do hope you have found this post on a beginners guide to investing useful
About the Author: Simon is the founder of Financial-Expert.co.uk, which is a blog which provides free investing courses for beginners. You’ll find dedicated guides to key areas such as how to invest in shares.