Investments Guide

Why invest?

If your savings goal is more than five years away, putting some of your cash into investments might make your money go further and help you keep up with rising prices.

Here are three main reasons to start investing:

1.     Your savings can’t keep up

Shocked at the bill when you do your big food shop or fill up at the petrol station?  That’s because the cost of living is rising.  Buying the same amount of stuff is becoming more expensive over the long term.  Low interest rates offered by banks and building societies are not enough to beat inflation.  For example, the average rate across all banks on easy-access accounts in February 2022 is 0.22%, vs. 0.56% back in February 2020, according to Moneyfacts.

2.     In the long run your money can really grow

Let’s say you invested £10,000, and assume a 5% growth.  And you put the same amount in a savings account, which paid you an interest rate of 1%.  After five years:

Savings pot = £10,510

Investments = £12,763

In fact, due to the impact of inflation eroding the spending power of the cash in your savings account, in real terms it would be worth even less. At the current rate of CPI (Consumer Price Index) at 5.5%, your savings pot would only be worth £8,087.

3.     The snowball effect of Compound Interest

Compound Interest was described by nonother than Albert Einstein as the “eighth wonder of the world”! 

Imagine a snowball, rolling down a snowy hill.  The longer it rolls down the hill, the more snow sticks to it, and the bigger it gets. And the bigger it gets, the larger a surface area it has to gather even more snow.  Now replace snow with money. The longer you give an investment to grow, the better. You’ll have your original investment, plus the return you make each year, and that in turn will earn interest.  Effectively the interest earns interest and so your money grows at a faster rate - the “snowball” effect.

What Are Investments?

Investments are something you buy, or put your money into, to get a profitable return. 

Most people choose from five main types of investment, which are grouped according to their common characteristics - AKA ‘Asset Classes’:

1.     Cash 

The savings you put in a bank/building society account

2.     Shares  

When you buy a stake in, or a little piece of a company.  For example, if a company is worth £100 million, and there are 50 million shares, each share is worth £2 (usually listed as 200p).  Shares can, and do, go up and down in value for various reasons.

There are two ways you make money from shares: 

a)     The value of your shares go up if the company does well (which is your investment return, and you profit when you sell) 

b)    Or by receiving a portion of the profits that these companies make, known as Dividends.  These are a bit like interest on a savings account - if a company makes a profit, it gives some of it back to you. This could be on a regular basis or a one-off. And just as you have a personal savings allowance for interest on savings, you also have a dividends allowance each tax year, where the first £2,000 you receive is tax-free. 

Here in the UK, on a daily basis, people buy and sell billions of pounds' worth of shares on the London Stock Exchange.  You can trade in any number of approximately 3,100 different types of companies.  Shares are listed on an 'index' and the UK's biggest is the FTSE 100 – the 100 biggest companies.

3.     Funds  

Instead of choosing your own individual shares, you can put your money into a mutual fund. This is essentially a group of shares (though Fund Managers can invest in other types of assets like bonds).  If buying a share is like backing the top player of a football team, a fund is like backing the whole team. So if one player doesn’t do well, there are others who can pick up the slack.  As such, funds are often less risky than individual shares because they include many types of investment.  That said though, the overall value can still fall even though funds have a range of assets to balance risk.    

Each fund is made up of 'units'.  Say you want to invest £1,000 in a fund; if each fund unit costs £2, you can buy 500 units. Six months later, if each unit is now worth £2.50, your investment is worth £1,250.

Funds can invest in almost anything – countries, energy, gold, oil, even debt.  But all funds have a theme – anything from: 

  • geography (European, Japanese, emerging markets), 

  • industry (green companies, utility firms, industrial businesses), 

  • types of investment (shares, corporate bonds, gilts), 

  • to the size of the company. 

What you choose will be down to your attitude to risk.

With funds you have a choice between:

a.     Passive funds, which track a stock market, or

b.     Active funds, where a professional investor, aka Fund Manager, uses their expertise to pick stocks for you, but charge you a fee for that service

4.     Property 

When you invest in a physical building, either residential or commercial (like warehouses and shopping centres).  We’ve all seen how house prices have increased, so it’s no surprise people invest in property.  A good way to invest in commercial property is buying an investment trust, where a manager selects a number of properties to invest in.

5.     Bonds (AKA Fixed Interest Securities)  

IOUs given in return for loaning money to a company or government (government bonds AKA gilts).  You will be paid a set amount at the end of the period when the bond “matures”, as well as regular interest payments known as coupons.  Generally speaking, bonds are considered lower-risk than shares, but as the risk is lower, so is the potential for a reward.  Your investment returns are likely to be smaller than shares as a result. 

The various assets owned by an investor are called a ‘Portfolio’.  As a general rule, spreading your money between the different types of asset classes helps lower the risk of your overall portfolio underperforming.  Keep in mind the age old saying, “don’t put all your eggs in one basket”.   

Returns

Returns are the profit you earn from your investments.  They can be paid in several different ways, depending on where you’ve put your money:

  1. Dividends (from shares)

  2. Rent (from properties)

  3. Interest (from cash deposits and bonds)

  4. The difference between the price you pay and the price you sell for – capital gains or losses.

With an instant access cash account, you can withdraw money whenever you like, and it’s generally considered a secure investment. The same money put into bonds, shares or property is likely to go up and down in value, but should grow more over the longer term, although each is likely to grow by different amounts.

How Fees Reduce Investment Returns

Managing investments takes time and money and service providers (such as fund management companies) will charge a fee.  This cost can eat into the returns you’ll receive and it’s something you can ask about before you invest.

Risks

The bottom line is there’s no such thing as a ‘no-risk’ investment.  At the heart of investing there’s a simple trade-off: the more risk you take, the more you can get back, or lose (and as such, the lower the risk you take, the less you’re likely to get back or lose).  

But while you’re always taking on some risk when you invest, the amount varies between different types of investment:

·      Money you place in secure deposits, such as savings accounts, risks losing value in real terms (buying power) over time.  This is because the interest rate paid won’t always keep up with rising prices (inflation).

·      On the other hand, index-linked investments, that follow the rate of inflation, don’t always follow market interest rates.  This means that if inflation falls, you could earn less in interest than you expected.

·      Stock market investments are generally expected to beat inflation and interest rates over time, but you run the risk that prices might be low at the time you need to sell.  This could result in a poor return or, if prices are lower than when you bought, losing money.

When you start investing, it’s usually a good idea to spread your risk by putting your money into several different products and asset classes.  That way, if one investment doesn’t work out as you hope, you’ve still got others to fall back on.

Please note:

The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

When should you start investing?

To start with, you should have an emergency fund of cash cushioning you in a savings account, made up of at least three to six months earnings, so you’re safe in the knowledge you’d be covered in the short term.  Then you should be ready to leave your money tied up in your investment for at least five years, to give it enough time to grow.  The longer you invest, the longer you have to ride out any bumps in the market.  But the bottom line is you don’t have to be super wealthy to invest.

The right savings or investments for you will depend on a range of different factors, such as your:

  • financial situation, 

  • life circumstances, 

  • risk appetite, 

  • and future goals.