Investing – the basics

There’s no one-size-fits-all solution when it comes to investing because everyone’s circumstances and attitudes to risk are very different.

The smart approach to building an investment portfolio (this means the collection of investments you hold) whether that’s via an individual savings account (ISA) or a pension, or outside one of these tax-efficient wrappers, is to be balanced and considered.

Knowing your options is an important part of understanding the investment world and can help ensure your portfolio is properly diversified – or in other words, that you don’t put all your eggs in one basket.

Here are some of the basics to help you get started choosing a home for your hard-earned savings.

Remember, if you’re not sure where to invest, or you’re looking for specific recommendations tailored to your individual circumstances, you should seek professional independent advice. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, see our guide on How to find the right financial advisor for you.

Investing in shares

When you buy shares in a business, you’re essentially buying a portion of a particular company. If that company does well, it may be possible to make a profit. Equally, however, if the company you’ve bought shares in runs into financial difficulties, you could end up facing losses.

Any company, no matter how profitable or well-established, can be hit by unforeseen events, such as the coronavirus pandemic which sent markets into freefall. The price of shares can also go up or down if sentiment about a particular company changes, if borrowing costs change, or when there’s political uncertainty, so you must be prepared for plenty of ups and downs.

Some, though not all, shares offer income in the form of dividends. Dividends are the portion of the company’s profit that it gives to shareholders to say thank you for backing the business. The size of these pay-outs can be affected by a number of factors, including company size and the earnings of the company in any given year.

Shares from big UK companies are traded on the London Stock Exchange and are known as listed shares. Smaller, more risky, companies are traded on the Alternative Investment Market (AIM). You can also access companies on exchanges around the world, such as the New York Stock Exchange, but you’ll need to be aware of currency risk. If, for example, you invest in shares that are priced in dollars or any other currency, any gains you make could be offset by a fall in value of that currency against the pound.

To buy or sell shares, you’ll need to open an account with an online broker – preferably one with relatively low charges. Some charge for individual trades – that is, buying and selling shares, while others charge a flat fee for as many trades as you like. You can compare the costs of different brokers and fund platforms at the independent and impartial comparison site, Comparefundplatforms.com.

Investment funds

A fund is a type of investment that contains lots of different shares. Your money is pooled with that of other savers and a professional fund manager, supported by a team of analysts, chooses which companies to invest in.

Most funds are either open-ended investment companies (OEICs) or unit trusts, which are both open-ended. This means that there’s no limit on the number of units or shares which can be issued, so if new buyers come into the funds, the fund manager can simply create more units for them.

Investing in funds can help spread risk, as you’re investing in a wide range of companies, so if one runs into difficulties, the impact won’t be as great as it would be if you’d only invested in one or two.

The fund manager can select firms he or she believes are already well-established, or those that are up-and-coming in the UK or overseas. Funds run by a fund manager are known as actively-managed funds, whereas those that simply track a stock market index, such as the FTSE 100 of Britain’s biggest companies, are known as passive funds.

Some investment funds are classed as income funds, which have proved very popular during the prolonged period of low interest rates as they offer the potential for inflation-beating returns, which can be hard to find. They do this by investing in companies that pay generous dividends that hopefully can be relied on year after year.

These funds are often favoured by those who need to receive a monthly income – such as those who have retired and need to supplement their pension income. It is possible to reinvest dividends, which can boost returns over time, thanks to “compounding”. This is when your returns are added to your investment and also earn returns.

There are also growth funds, where fund managers will look for companies that show promise of being able to grow over time. Such firms will reinvest dividends in their business, rather than paying out such profits to shareholders. Some growth managers favour smaller and medium-sized companies, believing there is more opportunity for growth.

There’s no need to choose between income and growth funds. Experts often agree that a portfolio with a mixture of the two is usually a good idea. That’s because most savers are looking for investments that generate an income, protect their capital and provide potential for capital growth. There are even some funds that offer a mixture of income and capital growth.

As your financial situation changes over time, you may need to make adjustments to your investment choices.

This often means tweaking the balance of growth and income funds if, for example, you need to boost your monthly income in retirement.

Investment Trusts

Investment trusts are another type of fund, where again your money is pooled with other savers and invested in lots of different shares.

However, unlike OEICs and unit trusts, Investment trusts are ‘closed-ended’. This means they are a fixed size and investors buy and sell shares in them to invest or withdraw money. You can only sell your shares if someone wants to buy them.

They are set up like a company with shares that trade on the stock market.

Each trust has its own board of directors, responsible to you as a shareholder.

Most investment trusts are also allowed to borrow, known as “gearing”, which is another special feature of these investments. If managers think there is a great opportunity somewhere, they can borrow money to use for further investments. This can be beneficial in a rising market. But the more borrowing a trust has, the greater the risk to your money.

Another quirk is that investment trusts can hold back up to 15% of their dividends during bumper years as reserves for any tough times. This means they are often able to deliver a steady income to investors, even in times of crisis.

Tracker funds

These are a unique kind of pooled fund run by a computer, rather than a manager.

As their name suggests, they aim to track a chosen stock market index such as the FTSE 100. These funds are usually much cheaper to run than actively managed funds, because there is no fund manager to pay for, so charges will be lower.

There are lots of different tracker funds to choose from. Some will buy shares in all the companies from a particular index, while others will hold a cross-section of companies.

Another option is exchange-traded funds (ETFs), which are floated on a stock exchange and traded in the same way as shares.

Like index-tracking funds, these aim to replicate the performance of a chosen index – for example the UK FTSE All-Share.

Bonds

Bonds – also known as fixed income securities – work differently to shares and are generally viewed as lower risk. They can provide an important way for investors to diversify away from equities, and therefore often form part of a balanced investment portfolio.

Bonds are effectively a type of IOU, offering a fixed income from money you ‘lend’ to the Government or companies who need to raise cash. They tend to be popular with more cautious investors who are looking for a steady and reliable income. However they aren’t risk-free. If, for example, the company issuing the bond runs into financial difficulties, it might not be able to meet its interest payments and there’s a chance you might not get your capital back.

UK government bonds, known as gilts, are considered the safest type of bond to invest in, as a financially stable government is unlikely to default on its payments.

Bond prices are impacted by movements in interest rates, where their value may go down if interest rates rise and vice versa, and the credit-worthiness of the issuer, along with the bond’s maturity date.

Seek advice if you’re unsure

There’s lots of jargon to get to grips with if you’re considering investing, but it’s vital not to put your money into anything you don’t understand. Make sure you’re clear on the risks involved and remember that investing is for the long-term, so you should only consider if you can afford to tie your savings up for at least five years, but preferably longer.

Are you considering investing or have you recently started investing? If so, we’d be interested in hearing from you. You can get in touch via [email protected] or post on the Rest Less Community forum.

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