By Karl Van Sielman
Investing can give you strong returns over the long-term and it's easy to start once you get the hang of the basics. We put together this easy-read guide to help.
In just a few minutes, you'll discover:
- What is an investment
- How risk can give you the edge
- How to get the experts to do all the hard work for you
- Start small and add small amounts over time
- Understanding your annual tax allowance
- If you're financially ready to invest
Over the long term, investing can be a win-win for everyone who gets involved. Here's what you need to know.
Think of a famous company. Nike, Amazon or Microsoft for example.
Investors buy tiny bits of companies like this in something called a 'share'.
If the company does well, and so grows and makes profits for its shareholders, the value of your share can go up.
If the company does poorly, like it makes a loss, the value of your share can go down.
To put it simply: you buy a portion of a company and your investment can go up or down in value. Remember, you could get back less than you invested.
Fact is, you can invest in all kinds of things. Property, government bonds and even gold.
You can buy them in the financial markets, a place where people buy and sell investments.
As you're about to see, you could make a significant profit from investments over the long term.
Does all this mean you should move all your money out of savings and into investments?
No – you want to hold both investments and savings so you're not relying on one or the other.
It would be prudent to save up enough money to cover any unexpected expenses before you start investing. You don't want to dip into your investments for spending money if you can help it.
As you've just seen, investments offer a bigger chance of higher returns over the long term. But why?
It's all because of risk.
As with many things in life, the more risk you take, the bigger your potential reward, and the bigger your potential loss.
Likewise, the less risk you take, the smaller your potential reward, and the smaller your potential loss.
Savings are where most people start, putting any spare cash to one side to build up a short-term safety fund in case of emergency. This money is often held in deposit accounts in banks or building societies, where the rate of interest will be variable or fixed. Penalties might apply if money is withdrawn before the end of the period. The rate of interest paid on money held in deposit accounts tends to be relatively low but the amount of cash you have shouldn’t fall in value. Remember inflation reduces the future spending power of money.
Investments are medium to longer term savings where varying amounts of risk can be taken. Investing is about putting money away either as a lump sum or regularly, providing the opportunity for your savings to grow in value over the long term. There is a wide choice of investment types each with their own pros and cons. For example, investing in riskier investments, such as the shares of companies in less developed markets, means that there could be more bumps along the way, although there is more potential for higher returns. Charges might also apply to investments.
Remember the value of investments can go down as well as up and you may get back less then was invested.
Work with risk – not against it
You can manage risk to help your money work harder.
For example, put your money into lots of different investments and you'll 'spread' or 'diversify' your risk.
Just like not putting all your eggs into one basket, you won't have all your money backing one company that could suddenly fall in value.
You can also invest little and often to help smooth out the zigs and zags of the market. More on that in a minute.
Another good way to manage your risk is to invest for long-term goals instead of short-term ones.
For instance, invest for a goal at least five years from now. That could be anything from a house deposit, university fees for children or simply to grow your own pension pot.
If your investment drops in value in the short term, you'll be less likely to panic sell before it has a chance to go up in value again.
To sum up, risk may sound scary at first. But it's the reason you could get a higher return on your money to begin with.
When you see it that way, risk is a good thing, so long as it's carefully managed. An easy way to manage your risk is to put your money into a fund.
Just like the dentist takes care of your teeth, estate agents help buy and sell your property and engineers fix your boiler, professionals can help invest your money too.
For instance, professional fund managers will pick and choose investments so you don't have to.
Think of a fund like a shopping basket containing the value of many investments. It could be a sensible way to manage your risk.
A fund may track the value of shares in global companies, government bonds, commercial real estate, gold and more.
Plus, fund managers undergo training and study for qualifications from the Chartered Financial Analyst Society.
This means your fund manager is qualified to manage money as well as being held to the highest of industry standards, as laid out by the Financial Conduct Authority.
The FCA is a financial regulatory body in the UK which aims to make markets work well for individuals, businesses and the economy as a whole.
As you can see, funds help make it quick to start investing even if you don't have much experience yourself.
Even better – you only need a small amount of money to invest in a fund.
You might think investing is complicated and is expensive and is only for a few people. But this isn't the case.
The truth is – nearly everyone has enough money to start investing. From as little as £50 in some cases.
What's more, you can use small monthly top-ups to your advantage. It's affordable, gets you into the habit of investing and helps spread your risk.
Simply put: a company's shares may trade at a lower price than usual. Stick to a monthly top-up, and you'll snap up these lower-price shares and average your total spend over time.
It's what's called 'pound-cost averaging'. You'll find it less stressful than trying to 'time' the market for the best price like a professional investor.
As you can see, having only a small amount to invest isn't a problem at all. It can in fact be a great way to start.
Of course, whether you top-up little and often or in big lump sums is up to you and depends on your situation.
You may have a large lump sum you'd like to invest straightaway, for instance maybe an inheritance or bonus from work.
Whatever you choose, remember you can shelter some of your potential investment profits in a tax-efficient ISA.
Do you want to hold onto as much of your money as possible?
Then tax-efficient accounts like a stocks and shares ISA and a pension could be for you.
Remember, tax benefits are subject to change and depend on your personal circumstances.
Stocks and shares ISAs
Stocks and shares ISAs work like cash ISAs when it comes to tax benefits, except they hold investments instead of cash.
Any interest and dividend payments in your ISA will be free of Income Tax, and any potential profits will be free of Capital Gains Tax too.
A stocks and shares ISA goes towards your annual ISA allowance, which is £20,000 for the 2021/22 tax year.
The sooner you open an ISA, the sooner you can make use of your annual allowance. You don't need a lot of money to get started – even £50 a month is enough.
A pension helps you put money away for retirement and, like a stocks and shares ISA, the money you put into it is invested.
Pensions come with a £40,000 maximum annual allowance, but you can’t pay in more than you earn in a year. The Government also adds an extra 20% to what you pay in (if you’re a higher or additional-rate taxpayer, you can claim back even more) – it’s like a top-up.
You can carry your unused pension allowances from the past three tax years into the current one, which means you could pay in more than your annual allowance. This is known as pension carry-forward – you can only do this if you’ve used up your current annual pension allowance first.
There's a tapered allowance for those earning more than £200,000 - when you add the value of pension contributions to your income, for every £2 by which that total is above £240,000 your annual allowance drops by £1, to a minimum of £4,000.
There’s a lot to take in when it comes to pensions and their allowances, and this is just an overview, so you can find more information and detail by reading what pension tax relief is all about.
What do you want the money for?
Once you know what you want the money for, you'll find it easier to choose how long to invest for.
- Want to buy a house? You could invest between now and five years and potentially end up with a sizeable contribution for your new home.
- Want to send your child to university? Consider a Junior Individual Savings Account. Your child will be able to withdraw the investments as cash when they turn 18.
- Want a comfortable retirement? Think about investing a portion of your earnings every month from now until you retire. Any potential profit will go towards your pension
You'll feel more committed to your investments once you know what you want to spend your money on in the future.
Whether you think investing sounds like a good idea or you're sitting on the fence, read our short article 'Am I financially ready to invest?'.
You'll find out how to prepare with savings, debts and long-term goals.
Just three quick questions and no more than a minute to read.