If you’re comfortable accepting the risks involved, investing in stocks and shares offers the chance to potentially generate a better return on your money than savings accounts.
This is really important at a time when savings rates aren’t keeping pace with inflation. However, there is a chance you could get back less than you put in, so it’s not for the faint-hearted.
Here are 10 things you need to know about investing to help you decide whether it’s right for you.
Contents
- The stock market tends to do better than cash over the long term
- You’ll need to be comfortable with the ups and downs
- Funds can help spread risk
- Realise the power of compound growth
- You don’t need to be a big earner to invest
- Investments can be tax-efficient
- Diversification is key
- Your money can have a positive impact on the world
- Check you’re getting value for money
- Reviewing investments is vital
1. The stock market tends to do better than cash over the long term
Historically, over long-term periods, returns from the stock market usually tend to far outweigh those from a savings account with your bank.
If, for example, you had invested £10,000 into the FTSE 100 index 20 years ago and reinvested all dividends your pot would have been worth £39,736 at the end of last year, according to calculations by investment service Hargreaves Lansdown.
If, however, you had invested £10,000 into a UK savings account over the same period, paying 2%, you’d have ended up with a savings pot totalling £14,859. Of course, there are no guarantees with investing, and there’s a chance you might get back less than you put in. It’s also worth bearing in mind that past performance can never be relied on as a guide to what will happen in the future.
Remember too that keeping significant amounts of money in cash, where it might seem safe, is not without risk. That’s because returns offered by savings accounts don’t currently keep pace with rising living costs, so your money will lose value over the long term.
That said, you should always make sure you have some savings in cash, ideally equivalent to at least three to six months’ income, so that you have money readily available in the event of an emergency.
If you’re looking to invest in an ISA, fund platforms such as Fidelity, Hargreaves Lansdown and AJ Bell can help narrow down your choices with recommended fund lists, which might highlight 50 funds out of the 3,000 plus available to UK savers. They also offer ready-made funds for a range of different risk profiles if you don’t want to pick investments yourself. Bear in mind that there are charges associated with stocks and shares ISAs and you’ll pay a fee to the platform as well as for the funds held.
2. You’ll need to be comfortable with the ups and downs
Stock markets rarely move in a straight line – they rise and fall. Experts recommend money placed in the stock market should be long-term savings for at least five years, but preferably longer.
That means when the market falls, there’s no need to panic because there will hopefully be plenty of time for it to recover.
A much-favoured investment strategy is to drip-feed money into your investments. By saving a monthly amount into an investment portfolio you can smooth out the highs and lows in share prices because when they go down your next contribution buys more units or shares, and fewer when prices rise. This is known as “pound-cost averaging”.
3. Funds can help spread risk
Instead of buying shares in individual companies it’s possible to save your money in a fund, which offers the opportunity to invest in lots of different stocks.
Money is pooled with that of other savers and invested by a fund manager on your behalf in companies that are already successful or perhaps those expected to flourish in the future.
These can be UK based, or companies in other countries in many different industries and sectors. It’s a good way to spread the risk as you won’t get hit so hard if any single company fails. While some companies in your chosen fund might suffer losses, hopefully others could rise in value and cancel out those losses.
4. Realise the power of compound growth
Investing money over a longer period of time means you benefit from what Albert Einstein called the seventh wonder of the world. He was talking about compound interest. This is the term for earning interest on interest, which can seriously boost your savings.
In simple terms your money earns a return in the first year, in the second year both the original cash and the return benefit from any growth from the first year. In the third year your investment is further enhanced by any returns achieved.
5. You don’t need to be a big earner to invest
Not everyone can afford to save as much as they would like, especially in these difficult times. However, even putting a little something away every month is better than doing nothing, and over time even small contributions could build up to a sizeable fund.
For example, investing £50 a month could potentially grow to a fund of around £17,700 after 20 years (assuming 5% growth and charges of 1.25%). Stretching to £100 a month could build a pot worth around £35,500, based on the same assumptions.
6. Investments can be tax-efficient
Thanks to the benefits of an individual savings account (ISA) it’s possible to save in stocks and shares and benefit from valuable tax perks. An ISA is simply a tax-free wrapper in which you can shelter up to £20,000 a year (the current annual allowance), and any returns will be free from capital gains and income tax.
Junior ISAs for 0-18 year olds come with a smaller allowance of £9,000 a year.
Pensions are also tax-efficient for investors, with contributions allowed to grow largely free of taxes. Like other investments, however, dividends on shares are paid to your pension scheme with a 10% tax credit deducted, and this can’t be reclaimed.
Pensions also offer an extremely valuable tax break. You get a tax top-up when you contribute to your retirement pot, at the rate of 20%, 40% or 45%. So, every £800 paid in by a basic-rate taxpayer, for example, will result in a contribution of £1,000. Higher-rate taxpayers can claim back an additional £200 through a self-assessment form, boosting their return even higher. This means your money can grow free of tax for decades.
7. Diversification is key
By owning different asset classes which each behave differently during the market ups and downs, it’s possible to create a portfolio which can handle any inevitable market downturns – by minimising risk and smoothing out returns.
Investors’ money should ideally be split between a wide range of investments such as shares, bonds, cash and even alternative assets such as infrastructure, property or gold. That way, if one type of investment underperforms, hopefully others will perform better, offsetting any losses.
8. Your money can have a positive impact on the world
There’s lots of opportunity to invest for good. Many funds back companies dedicated to making a positive impact on the environment or society. Fund managers will look for companies that have a good record on environmental, social, and governance (ESG) issues.
The main areas that fall under the environmental bracket are a company’s approach to climate change, nuclear energy and toxic waste.
Social investment refers to issues such as treatment of staff and suppliers, and to what extent a company upholds labour and human rights.
Governance holds a company to account on leadership, matters of executive pay and its stance on shareholder rights. Without investment often these businesses would not be able to raise money to develop and expand. You can find out more about ethical investing in our guide What is an ethical investment ISA?
9. Check you’re getting value for money
As an investor you will pay a fee for the running of your investment, as well as to the company – or platform – responsible for holding it. Investment charges differ between every single fund and the same goes for platforms.
So just make sure you’re getting value for money. There’s no one-size-fits-all when it comes to platforms. Do a comparison to make sure you’re not paying over the odds.
10. Reviewing investments is vital
Once you have taken the plunge and invested your money, make sure you check every year to ensure your investment choices are performing in line with your expectations. If they’re not, try and understand why and then look to make changes if you need to.
If choosing or reviewing your own investments feels too daunting then you can enlist the help of a professional financial advisor who can recommend which ones are right for you based on your investment timeframe and your approach to risk.
You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guide on How to find the right financial advisor for you.
You can also learn more about investing in our article Investing – the basics.
Make sure you regularly review your pension investments too. You can find out more about this in our guide Where is my pension invested?
If you’re thinking about getting independent financial advice, financial services company Fidelius is offering Rest Less members a free initial consultation with an independent financial advisor to chat about your finances, where you are now, and where you want to go.
There’s no obligation, but if they feel you’d benefit from paid financial advice, they’ll go over how that works and the charges involved. Fidelius is rated 4.7/5 from over 1,000 reviews on VouchedFor, the review site for financial advisors.
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