Introduction to Investing Part One: Why, What, How…
Are you thinking about investing but not sure where to start? Don’t worry, this is the start of a new series that explains how it works, why you should consider it, and provides details about all the different types of investment vehicles. You’ll learn how to set achievable goals, understand the risks, and how to keep an eye on any investments you make.
Let’s start right at the top:
What is Investing?
In the simplest terms, investing is sending your money out into the world to a company, financial scheme, or another investment vehicle so that you might potentially receive more money back in the future. The most common investments are usually tied to an overall goal like pensions to fund your retirement, savings to buy a house, or saving for your children’s future. Investments typically don’t offer you fast returns. They are usually long-term, meaning you wouldn’t expect to get significant returns from your investment until many years have passed. In some cases, your money may be tied in for a set duration of say 5 to 10 years, maybe longer.
The different types of investments you may come across:
- Investment Funds
We will go into more detail about what each of the investment types means, how they work and the benefits of each vehicle in part two of our series.
Which is best: saving cash or investing?
Saving regularly and as early as possible is great because of the wonder of compound interest, which is when you reinvest your initial investment plus the interest (or profit) you have received, rather than cashing out. Compound interest is one of the best ways to accumulate wealth, because your money grows much faster year on year even without the need for you to keep topping up your investment account.
However, investing means you may generate a higher return on the pot, which with compound interest, grows larger, demonstrated in the graph below:
As you can see, investing has the potential to deliver more significant returns than holding cash savings. But investing is not without its pitfalls. They all come with a level of risk that could see your initial investment lose money rather than make money. Opportunities with the largest risks can deliver you higher returns – but the potential for downside is bigger.
Why do people invest?
Firstly, your savings are negatively affected by inflation. Inflation is the increase in price for goods and services over time. For example, a cup of coffee in 1970 may have cost £0.25, now in 2020 the same cup of coffee costs £2.20. Whilst the product stayed the same, the amount it costs has risen, meaning the value of your money has changed – £1 doesn’t stretch as far as it used to. Leaving your money in standard cash accounts at the moment means that it’ll be subject to interest rates which may be lower than the current level of inflation (1%), meaning your saving pot is decreasing in value in real terms. You’ll find that your money won’t be accruing much interest, whilst the price of everyday items gets more expensive.
Secondly, people are attracted to the possibility of having their money working for them; especially when the interest they are getting on their savings is currently so low. Increasing your wealth and getting healthier returns without having to work extra hours to achieve it is an attractive thought. Research has found that the longer you invest your money, the less likely you are to lose in the long run, and it’s been proven that investments over a ten year period make positive returns 99.4% of the time. In contrast, investments over one month only have a 63.9% chance of producing positive returns. Investing isn’t necessarily a difficult or overly complex thing to manage – in fact, if you have a workplace pension you’re already investing!
How much can I invest?
There is not a set amount that is better, or worse, for investing. However, if you are paying off debt (particularly high interest debt) or don’t have an instantly accessible emergency fund available (3-6 months+ of your monthly expenditure), it’s sensible to focus on these goals first before investing. The interest rates on debt may be much higher than the expected returns on investments, so it always makes sense to clear them first.
After that, decide how much is needed for your own financial circumstances. Generally, the golden rule is to “not invest what you can’t afford to lose” and remember, whatever you invest may not be instantly accessible to you if you need it or could incur a penalty fee if taken out early.
A good place to start is to use the 50/30/20 rule to work out how much money you have to save each month. This rule takes all the money you make in a month and splits it down to how you should spend/save it. It looks like:
- 50% on essential bills and outgoings.
- 30% on discretionary payments (lifestyle funds).
- 20% on saving/investing.
If that sounds like too much for you right now, start small! By making minimal regular payments into the investment account, as long as you keep topping it up, you’ll soon have a good pot. There are also apps that let you ‘save the change’, rounding up anything you spend to the pound and investing it. So if you buy something that costs £2.50, you’ll automatically invest the other 50p. They’re designed to get you investing little and often, with money that you won’t miss. Just check the minimum amounts required to invest each month, and make sure you’re comfortable with that.
What returns can I expect?
Returns on your investments are often given as ‘expected’ because what you actually experience is dependent on many factors, including the type of investment you’ve made, the performance of the stock market, and the level of risk you took. In the past, the average return on long term investments for the FTSE 100 was around 7.4% p.a (10 year horizon, dividends reinvested, data to 2019). This is compared to just an average of c. 1.8% savings rate across the same period. Note, past returns are not indicative of future performance.
However, the past decade has been a volatile time for markets and the wider economy and we’ve seen many highs and historic lows which has led to uncertainty in the stock markets. This graph shows the index highs and lows of the FTSE 100 (The 100 largest companies listed in the UK) over the past 20 years. As you can see, there have been some drastic drop off points (2003 and 2009). However with the possibility of Covid-19 causing a new recession, we could see more volatility in the market.
Source: London Stock Exchange, index values shown. Note past returns are not indicative of future performance.
There are other risks to consider like the closure of funds which have underperformed. In this event, investors may not be guaranteed their investment back.
One way people try to reduce the risk of investing is by diversifying their portfolio. This means that they spread their money across many different types of investments to make the overall portfolio less risky, and this is something that we’ll cover in detail later in the series.
In upcoming articles, we’ll be covering the basics to investing, but before you make any firm choices on where to put your money, be sure to get some guidance from an independent expert (you can connect with one who is matched to your financial needs on the Bippit app). You’ll want to discuss all the possibilities with your advisor and understand the pros and cons of different approaches while you set some long-term goals.
You should also consider where you want to invest – it may make more sense based on your goals to put more money into your pension pot or use it to pay off your mortgage rather than a different type of investment vehicle. You may want to use tax-efficient savings accounts, which are often topped up with money from the government, such as using the maximum of your ISA’s and pension allowance.
Remember that the best returns are usually tied to long term plans so you’ll want to be sure that any decisions are best for your financial goals. Speak with your dedicated expert in the Bippit app to discuss the risks involved with investing your money. No investment is guaranteed high returns, but there are definitely less riskier options out there. You may also want to consider how your investments reflect your beliefs and values, such as sustainable and ethical funds, but we’ll cover more about this in the next part of the series.
Check back next week where we’ll be continuing our investing for beginners guide. We will be talking about all the different areas of investing, from Sustainability funds to Bitcoin and everything in between!