Over time, investments can become powerful tools for creating financial growth. All kinds of investments present varying degrees of risk to your capital, which means that the value of your investment may go up and down and you may get back less than you invest.
This is not a personal recommendation. If you need a personalised recommendation based on your personal circumstances, you should seek financial advice.
Here are two important questions to ask yourself, when you’re getting ready to invest.
Do you already have enough money set aside to cover emergencies?
Smart investors ensure they have sufficient cash to cope with unexpected expenses in case of a rainy day. We recommend that you seek advice from a financial adviser if you’d like help determining your particular financial needs.
Is your financial goal at least a few years away?
Many investments are best suited to medium- or longer-term goals. If you’re planning for the shorter term, this may not be the best fit for you right now. All investments carry some risk, but when you’re able to be patient you could stand a better chance of reaping bigger rewards.
By thinking carefully and weighing the facts about different funds and investment strategies, you can make an informed decision about which balance of risk and growth potential best suits your future planning.
Here are some articles and videos to help you learn more.
Saving and investing
Saving: how does it work?
- Saving is typically for smaller, shorter-term goals (usually no more than three years) such as going on holiday, buying a car or just to have money on hand for emergencies.
- Easy access to your cash
- Usually you put your money in a bank or building society account – or maybe take out a cash ISA. Some savings accounts may have a fixed term, or limit how often you can take money out and may require a notice period
- Minimal risk
- The saving account value will not fall, but real value can fall if inflation is greater than the interest rate
- Earn interest
- You can earn interest by putting money in a savings account.
Investing: how does it work?
- Investing can help you reach bigger long term goals (typically five years or more) such as your child's university education or your retirement.
- Harder to access
- When you invest your money, it's typically not as easy to get your hands on it quickly as compared to a savings account.
- Invest directly in shares, or via a fund
- In a fund, your money is pooled with that of other investors. In turn, the fund could invest in anything from company shares to government bonds or even property.
- Always involves risk
- Values can go down as well as up and you may lose some or all of the money you invest.
- Potential for a higher return
- Over the long term there is a chance your money will grow more, but remember you could lose all the money you invest.
In the world of investments, most of us would jump at the chance to grow our money substantially, safe in the knowledge that there was no chance of losing anything.
Unfortunately those opportunities don't exist.
In a sense, every financial decision we make involves risk. Even if you keep your money in a safe, you're running the risk that if prices increase what you can buy with your money will be less.
Then there's the more familiar kind of risk: if you put money into the shares of a company which fails, the value of those shares could reduce to zero.
Getting an understanding of the different investment risks – and deciding how much risk you're comfortable with – is an important step to planning for a healthy financial future.
Five steps to understanding risk
Please read each of the five steps carefully
1. What is investment risk?
High risk funds have the potential to make a lot of money – but equally all the money invested could be lost. All investments present varying degrees of risk to your capital. This means that the value of your investment will go up and down, and you could get back less than you invested.
In addition to this, depending on what you have invested in, you may also be subject to other risks, such as foreign exchange rates, property illiquidity and so on. When you are thinking about investing, you need to fully understand where your money is going and the risks associated with this by reading the appropriate literature.
Overseas investments involve an additional layer of uncertainty: exchange rates. If funds are withdrawn when the exchange rate is poor, the investor may not get as good a return on their investment.
2. What is volatility?
Volatility refers to how often, and how far, an investment's value rises and falls over time.
Investing in funds with high volatility could mean having very little money at a time when it's needed – but such funds often bring more opportunity for high returns. Lower risk investments tend not to change as much over time, but can offer lower returns.
3. The effect of inflation on investments
Over time, if savings don't grow as quickly as the rate at which prices increase, the value of that money becomes less.
No-one knows how quickly prices will increase in the future, the average annual inflation rate in the UK over the past 10 years has been around 2.7% (as measured by the Consumer Prices Index).
The table below shows what something that costs £100 now could cost in the future, depending on inflation.
|What you'd need to buy goods that cost £100 after…||Average annual rate of inflation|
4. Why time is important
- For most people, it makes sense to keep part of their savings to hand ‘just in case'. This might mean choosing an account that combines very low risk with instant access.
- Investors with long term goals – paying school fees, perhaps, or retirement planning – might need a longer period of investment.
- In the very short term, the risk of losing money from a more volatile investment could outweigh the inflation risk involved in holding a low-risk product. But as the length of time increases, this starts to reverse.
5. Reducing investment risk
- By investing in different types of assets at different levels of risk, poor performance in one could be balanced by good performance in another. Of course this depends on the type of assets invested in – each situation will differ.
- Taking a high-risk approach to investing may lead to a high pay-off – but it might also lead to a loss, since riskier investments are more likely to come unstuck. A low-risk approach may be safer, but might not bring in as much reward. Investors may want to balance their investments in line with the overall level of risk they want to take.
- Most investments will rise and fall in value over time, with the most volatile types showing larger and more pronounced swings than lower risk types.
- Investing a regular amount over a period of time reduces the overall risk being taken. This is because more of an asset is bought when its price is low and less when it's higher.
- A risk-targeted fund invests with the aim of keeping to a certain level of volatility, which could be high or low.
Understanding different attitudes to risk
Nobody but you knows what level of risk you're comfortable with but you might find that hard to pin down when investing your money. We’ve created a number of profiles outlining different types of investors and the level of risk they are likely to be comfortable with. This does not constitute a personal recommendation.
Savings…for those who want to keep what they've got
A typical saver will:
- Be uncomfortable with the thought of losing the money they already have
- Be happy to prioritise capital protection over growth potential
- Understand increases in the cost of living will reduce how much they can buy with their money in the future
- Understand that to achieve higher returns without taking investment risk they may need to lock their money away for a fixed period of time.
Lower to Medium
An investment which carries some risk…investors won't want to see too many ups and downs
A typical investor will:
- Be looking for a better return than bank or building society accounts usually offer, but want to limit the amount of risk they're taking
- Understand that keeping potential losses down will also limit how much their investment could earn
- Know that the value of an investment can go down as well as up and that they may get back less than they invested
- Realise that unlike a bank or building society account, the value of these investments will fluctuate meaning that investors may need to wait in order to optimise when they take their money.
- An investment which carries some risk…investors won’t want to see too many ups and downs
Medium to Higher
In investment with a level of risk that sits somewhere in the middle. Investors should be comfortable with the balance between risk and growth
A typical investor will:
- Be looking for returns above inflation and won't mind taking some risk with their money to get there
- Be prepared to see daily changes in the value of their investment and will understand that they could get back less than has been invested
- Prefer to spread risk by investing in a wide range of assets
- Accept that including some lower risk assets may limit the potential returns that they could make.
An investment with a high level of risk. Investors should accept that they will see swings in the value of their investment
A typical investor will:
- Want returns above inflation and won't mind taking risk with their money to try to do this
- Prefer to invest in higher risk assets for the potential higher growth, rather than lower risk assets which aim to limit losses
- Know that higher potential returns mean that they're likely to see the value of their investment go up and down every day
- Accept that there is an increased possibility that the value of their investment will go up and down and they may get back less than has been invested.
Managing your money
Perhaps, like many of us, you have a vague feeling that you should be saving – but haven't thought clearly about your objectives, or how much you can really afford to save. And even if you are managing to put some money aside, it's important to think carefully about what you're trying to achieve with your saving – and whether you're saving enough.
Ask yourself a couple of questions…
Can you afford to save?
All of us need a 'rainy day' fund at the very least. But perhaps you have urgent demands on your cash, or have debts which you might be better paying off first.
Are you saving now - and if so, could you save more?
It could be that you started saving a few years ago, but haven't reviewed the amount for a while. Maybe you could manage to increase it.
I just don't know where my money goes!
To answer these questions, you need to know where your money is going now, and whether you could rearrange your finances so you could start saving, or save more.
My budget planner could help here. It’s a simple online tool to help you find answers to the age-old question of where your money disappears to each month!
Identify where you can save
Once you've got a clearer idea of your regular expenses, it's worth drawing up a list of ‘must haves' and ‘nice to haves' so you know where you might be able to do some economising.
|Must have||Amount per month|
|Gas & electric||£109|
|Transport to work||£194|
|Nice to have||Amount per month|
You might look at one of your ‘nice to have' items such as your working day latte and think ‘OK, I could do without it... but would it really make much difference?' In fact, it's surprising how small savings can add up.
Here's an example...
You drink one cup of latte every working day from your favourite coffee shop. Let's say it costs £2.40
Instead, you brew yourself a cup of similar quality coffee at home or work. We'll estimate that this saves you £37.50 a month, or £450 a year.
You put the savings into a deposit account with average earnings of 1.5% interest (and leave the interest in the account)
Over the next decade, the £37.50 saved each month could grow into £5,022.24. This could be a car. Or money towards a deposit on a house.
That one cup of coffee can really add up.
You can use our ‘cut back and save' calculator to see for yourself how small economies can lead to big savings. Give it a try:
An ISA, or Individual Savings Account to give it its full name is simply a savings or investment account which won't incur income tax or capital gains tax on the interest or investment returns. A stocks and shares ISA allows you to invest in a tax efficient way in a wide range of investments.
There are two main types of ISA: a stocks and shares ISA you can invest through and a cash ISA for bank account type savings. This information is based on our current understanding of tax rules and these are subject to change.
Using your ISA allowance - your choices:
You can put the whole of your allowance (£15,240) into a cash ISA in the 2016/2017 tax year
You can put the whole of your allowance (£15,240) into a stocks and shares ISA in the 2016/2017 tax year
You can 'mix and match' and transfer money between the types. However, you can only contribute into one of each type of ISA per tax year
Of course, you don't have to use the full amount of your ISA allowance - it's only a maximum amount. The minimum amount you can put in an ISA varies from one provider to another. You can also choose ISAs which allow you to pay in regularly if you don't want to pay in a lump sum.
What are the main types of ISA?
- Save without paying tax on any interest earned
- Many offer easy access to your money – useful for short term savings
- Note that inflation reduces the buying power of money
- Various accounts are available - for example, you could set up an instant access account so you could have your money as and when you need it; or a fixed term account which could enable you to achieve greater returns.
Stocks and shares ISAs
- A tax efficient way of investing your money.
- You may be able to invest in funds, gilts and shares, all within the same ISA. Investments such as these are generally considered medium to long term options, say 5 years or more.
- Depending on the type of investments you choose, the value of your investment could go up and down and may be worth less than you have paid in.
How do ISAs work?
- You will get a new allowance each tax year and you can’t carry over any unused portion of your ISA allowance into the next tax year.
- You can pay into an ISA every tax year and as long as you keep your money within the ISA you'll still benefit from the tax-efficiency.
- If your provider allows, you can now withdraw money from an ISA and pay it back in again without affecting your £15,240 allowance. You just need to make sure that any money you withdraw is paid back in during the same tax year.
- You can choose to transfer an ISA to another provider. Some providers may charge for this. The nature of a cash ISA and a stocks and shares ISA is different, so if you are moving from a cash ISA you need to understand the differences between the two types of ISA, in particular that with a stocks and shares ISA the value of your investment will go up and down and you may get back less than you invested.
- You could use an ISA to provide you with an income.
- The government have introduced a 'Help to Buy ISA' whereby first time buyers will receive a £50 bonus for each £200 they save, up to a maximum bonus of £3000. This is a Cash ISA only and gets rewarded when you buy your first home, using the Cash ISA as all or part of the deposit. We currently do not offer a 'Help to Buy ISA'.