Fundamentals of investing for beginners

CRYPTO PUMPS BITCOIN

Fundamentals of investing for beginners

Investing can seem scary when you don’t know what you’re doing.

This guide explains what investing is, the risks involved and suggestions on how to build your first portfolio.

What is investing?

Investing is essentially buying something that you think you will be able to sell at a higher price later on.

Let’s clarify what investing isn’t: investing isn’t stashing your cash in a savings account.

While we all need cash in an instant-access account for emergencies, there’s no chance of you growing your money beyond the small amount your bank will pay in interest rates. If you want an idea of what you can earn on a savings account here are the top-paying ones.

At the other end of the scale, investing isn’t gambling. If you make a wrong bet at your local bookies, you will lose all of your money.

In contrast, while you’re likely to experience losses when investing, and you may not get back what you put in, you’re less likely to lose the lot compared to gambling. With investing there is also a chance you make up for those losses over time.

There also isn’t one magic formula to investing, but there are some sensible strategies you can consider adopting.

Why should you consider investing?

1. Building up cash isn’t always enough
It is important to stash some cash in an easy-access account for emergencies. But if you have substantial savings then leaving it all in cash may not be the best idea.

This is particularly true when the cost of living is rising as rapidly as it is now.

The price of goods is becoming more expensive over the long term. Meanwhile, the relatively low interest rates offered by banks and building societies are not enough to beat inflation.

This means if you leave all your life savings in a poorly or even average performing account, the value of it is actually falling.

2. Your money can really multiply in the long run
Investing can give your money the best chance of growing in the long term.

For example, let’s assume you invested £10,000:

If you put the money in a savings account paying you an interest rate of 1% that pot would be worth £10,510 after five years
By comparison, if you invested the money (assuming 5% growth) then the same pot would be worth £12,763 after five years

And actually 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.

3. The power of compound interest
This is what Einstein called the “eighth wonder of the world”.
Imagine a snowball, rolling down a snowy hill. The longer it rolls down the hill, the more snow it captures, and the bigger it gets. And the bigger it gets, the larger a surface area it has to capture even more snow.

The longer you give an investment to grow, ideally 5 years at the very minimum, the better it could be. You have your original investment, plus any return you make each year, and that in turn will earn returns over time.

Effectively, any gains you might earn and then reinvest, are themselves likely to increase in value over time and so your money grows at a faster rate, which is why it’s a snowball effect.

Capital at Risk. All investments carry a varying degree of risk and it’s important you understand the nature of these. The value of your investments can go down as well as up and you may get back less than you put in.

What should I do before I start investing?

Before you buy shares or funds, it’s a good idea to:

Pay down any expensive debt such as a credit card or overdraft. Otherwise the interest payments are likely offset by any investment gains. Read more about whether to pay down debt or save.
Make sure you have savings of between three and six months’ earnings and keep it in one of these top-paying easy-access accounts.. This is money for emergencies like your boiler breaking.

If you are still worried about investing, it is important to bear in mind that nothing is risk free when it comes to investing.

This is because:

When investing the markets can go up and down
But with saving inflation can eat into your pot

So while keeping your money in cash may feel the safest option, you are likely to be losing money in real terms. The rising cost of living means your money won’t go as far in the future.

Still, when it comes to investing, keep in mind that the value of your investments can go down as well as up and you may not get back all the money you put in. All investments carry a varying degree of risk and it’s important you understand the nature of these risks.

Questions to ask yourself before investing

Make sure you understand what is motivating you to invest.

Ask yourself:

What are my investment goals?
How long am I happy to leave my money tied up for?
Am I comfortable tying my money up in investments for at least five years? (if not, it might not be a good idea to invest)
How much can I afford to invest?
How much could I stomach seeing my fall in value along the way?
Can I hold my nerve and avoid selling if my investments drop? (you should consider waiting for markets to rise again to avoid crystallising losses)

Choose a tax-free wrapper to hold your investments

There are government-approved tax-free wrappers that are an ideal home for your investments.

These include:

ISAs (specifically a stocks and shares ISA)
Pensions

Both of these products protect your investment profits from you having to pay capital gains tax and dividend tax.

ISA
The potential gains you can make through investing in a stocks and shares ISA are far greater than through the interest rates you would earn through a cash ISA. Find out how stocks and shares ISAs work, or see the best options according to our independent ratings.

The growth you get from the money in the ISA is also tax-free. So if you sell some shares held within an ISA and make a profit, you will not pay a penny in capital gains tax.

The ISA allowance for the 2022/23 tax year is £20,000. For example, if you put £12,000 in a cash ISA, you will be able to put £8,000 towards your stocks and shares ISA.

Pension
Pensions are another tax-free wrapper for your investments that come with an added perk in the form of tax relief.

Bear in mind that pensions are long-term investments. You can’t access the money in a private pension until you are 55.

Choosing an investment platform

The easiest and cheapest way to invest is typically through an investment platform.

Just like when you purchase sports clothes or jewellery, there are “shops” for buying and selling shares and funds.

They are often called “fund supermarkets” which is just another name for an investment platform. Most will have useful websites and apps to help guide you through the investment process.

You will likely be charged three types of fee:

One for using the platform
Another when you buy or sell your investment
If you buy a fund, you will also have to pay a management fee (this fee is separate to the platform)

A warning to beginner investors: Always. Watch. Fees.

The fees charged by the investment companies can erode the money you make, which we explain here. So, make sure you are getting good value for money.

What can I invest in?

We have outlined some of the most common types of investments below.

It can be best to invest in something you understand. So if you decide to buy shares in a company, check that it’s a company that you know about or even use yourself.

The same can be said for financial products. If an investment product seems complicated and you’re struggling to wrap your head around it then it may be best to avoid.

Shares

A share is a little piece of a company. When you buy a share you own a slice of that firm, so when it does well, you do too.

You gain from investing when:

The value of your shares goes up if the company does well (which is your investment return)
Or by receiving a portion of the profits that these companies make, known as dividends

The 100 biggest companies in the UK are listed on an index called the FTSE 100. Want to know how to invest in the stock market as a beginner? We explain how to buy shares.

Here are the pros and cons of buying stocks yourself:

Pros

You can pick the exact company you want to buy stocks for, from Rolls-Royce to Hotel Chocolat
If the company is successful the rewards can be substantial in share price increases or dividend payments

Cons

You are picking the shares so you have to make a call on the future growth of companies
If you buy stocks with a firm that performs badly, you could lose your money

Bonds
You lend money to a company or country. 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.

Pros

Generally speaking, bonds are considered lower-risk than shares.

Cons

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.

Funds
Instead of choosing your own individual shares, you can put your money into a mutual fund. This is effectively a group of shares, though managers can invest in other types of assets like bonds.

If buying a share is like backing the star player of a football team, a fund is equivalent to picking the entire squad. So if one player doesn’t do well, there are others who can hopefully pick up the slack.

You have a choice between:

Passive funds that track a stock market
Active funds where a professional investor picks stocks on your behalf

Here are the pros and cons of funds:

Pros

A manager uses their expertise to decide which shares and range of assets to buy and sell
Funds include many types of investment so are often less risky than individual shares

Cons

Fund managers charge a fee
The overall value can still fall despite having a range of assets to balance risk

Property
We have all seen how house prices have increased so it’s little wonder that people invest in property.

While most people think of residential property investment, you can also invest in commercial property like warehouses and shopping centres.

A good way to invest in commercial property is buying an investment trust where a manager selects a number of properties to invest in.

Precious metals

You could also invest smaller amounts in other asset types, such as precious metals like gold and silver.

Precious metal investments can help diversify your portfolio and tend to be uncorrelated to the stock market. In other words, if stock markets fall, you may find that the price of gold rises as people flock to this “safe haven” asset to house their cash.

You can invest in precious metals by buying an investment fund that specialises in this sector.

DIY or ready-made?

Be honest: how much time and brain space are you prepared to dedicate to your investments?

If you are keen to go down the DIY route, picking your own shares is like tending to an allotment: it’s not a short term solution and it will require careful monitoring.

After the initial excitement of picking your own stocks, you may realise that you don’t have the time or expertise to go it alone.

Luckily, there are solutions to this:

You can buy shares in a few actively managed funds where a professional stock picker will select investments on your behalf
Invest in a tracker or exchange traded fund (ETF) which mimics the ups and downs in the stock market. This tends to be a low-cost option.
Another option is to buy shares in a ready-made portfolio

What is an actively managed fund?

This is where managers buy and sell a pool of investments on your behalf to try to outperform a particular market.

For this, you will have to spend time finding a fund manager with a good track record whose investment technique you believe in.

The fees are higher than for tracker funds, but they have the potential to outperform the market.

Find out more about how to choose investment funds.

What is an ETF in investing?

ETF stands for exchange traded fund. An ETF will invest in a pool of companies that are part of an index such as the FTSE 100 or S&P 500.

An index like the S&P 500 measures the share price performance of the 500 largest listed firms in the US. So if you bought an ETF that tracks the S&P 500, you would be investing in the 500 largest companies in the US.

Unlike a mutual fund, ETFs are traded on a stock exchange in a similar way to buying a direct share in a company.

With ETFs, no one selects stocks on your behalf, so they tend to be low cost compared to actively managed funds. This has made them very popular.

What is a robo-adviser?

For an extra helping hand, you could look for a ready-made investment portfolio, where you don’t even need to pick the shares or funds. Here are the top-rated investment platforms.

As the name suggests, the portfolio is created and managed for you. You usually select the level of risk you want to take, such as cautious, balanced or adventurous.

Diversify your portfolio

Diversification means having a wide range of assets that perform differently in certain conditions.

Or as the old expression goes: don’t put all your eggs in one basket.

It means that no matter how the economy is doing, some types of investments will thrive more than others.

You only really need to worry about this if you are picking your own shares and funds. This is because if you have opted for a ready-made portfolio, the investment should already be diversified.

You can diversify by:

Asset class, such as buying shares and bonds along with a fund that tracks the price of gold
Sector, such as making sure you have a mix of financial and industrial companies
Geography, such as taking advantage of a booming American or Indian economy while European companies stagnate

But don’t go overboard…

Do not confuse diversification with owning dozens of investments. A portfolio with too many holdings will typically require more monitoring and often lacks focus.

If you buy too many funds, you might end up with some overlap if the fund managers own the same companies.
How much money should a beginner invest?

It all depends on your financial goals and personal situation.

Remember that it’s always a good idea to have an emergency fund of at least three to six months worth of essential outgoings in an easy-access savings account before you invest.

You should be prepared to leave your money tied up into your investment for at least five years to give it enough time to grow.

Some investment platforms now let you invest with just a few pounds. So you might want to start with small amounts first to try out the features before trickling in more of your savings as time goes on.

You don’t have to be super wealthy to invest. Find out how to invest with little money here.

Lump sum or regular savings?

Investing a lump sum will get your money working for you immediately and compound any returns from the start.
However, if the market dips, the whole sum will be exposed to the fall.

If you drip-feed a fixed amount over time, it can smooth out the highs and lows of the market. In other words, you will look to buy fewer shares when prices are high and more when they are low.

This is known as pound-cost averaging.

The drawback is that you can miss out on the full benefit of rises in the markets in the early years as you will have a much smaller sum of money invested to begin with.

AUTHOR: JEREMY WOLFE