Investing Principles
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Investing Principles
Tracey O’Reilly-Johnston explains the key investment principles.
What is investing and how does investing work?
Most of us understand how saving works, and normally we use our savings for short term goals and needs. Saving means putting some of our wages at the end of each month into a separate bank account. We might use this as an emergency fund, or for a holiday or a new car.
In very simple terms, investing is when we set money aside for the future, and we put it to work. Investing is essentially buying into something that we believe will increase in value over time, giving us a profit.
Investing comes with the potential for greater rewards over time, which is why some people use investments to reach long-term goals like retirement, saving for children’s education or simply for a better return than you might get on cash deposits with the bank.
The key thing is to have some money saved up before you start investing. We would recommend that you have an emergency fund to cover say three to six months of your living expenses first. That gives you peace of mind that you have money available for the unexpected, without needing to dip into your investment fund.
The value of investments can – and do – jump around. That is totally normal. Ideally, you should plan to set aside your investment for at least five years to give it a better chance to ride out any short term fluctuations in the markets. We would recommend investing as soon as you can, for as long as you can. That gives it more opportunity for growth.
You don’t need to be an expert or even be very wealthy to start investing. It’s easier than you might think. Often the scariest thing for people thinking about investing is knowing where to start.
What are the common ways to invest? What are the main asset classes?
Most people who invest put their money into stocks and shares, funds, bonds or collectives but there are alternative investments. Some people use property – they’ll buy investment properties to rent out. There’s no shortage of options for what you can invest in – but there’s also no need to be overwhelmed by the choice.
If you’re not sure what to invest in, speak to an advisor. An easy and convenient way to invest is in funds. They offer diversification and professional management which is what makes them a very popular choice for both experienced investors and those who are new to investing.
What is an investment fund?
A fund is a collection of investments chosen by a fund manager, who’s trying to achieve the fund’s investment objective. That could be to grow the investor’s capital or to provide a decent level of income. When you invest in a fund, you buy a slice of the fund’s underlying Investments. You receive units, which are a proportion of the overall pot.
Funds can be invested in many different types of assets – shares, bonds and even property.
Some are focused on just one type and some are a mix. When you invest in funds you’re buying a range of investments – you’re not putting all your eggs in one basket.
If some investments in the fund perform badly over a certain period, others may perform well. That spreads your risk, which is known as diversification. There are many different types of funds on offer. An especially diverse option is a readymade portfolio, which is a collection of investment funds, often from different regions around the world.
How should I choose an investment fund?
The first thing you might be tempted to look at when you’re choosing a fund is how it has performed in the past. But as we always say, past performance isn’t a guide to the future. While a fund’s track record can help you manage its future potential, it’s only really showing you a part of the picture.
That particular fund manager may have been very skillful and chosen their investments very well – or maybe they’ve just made a few lucky choices. The area they have invested in may have performed particularly highly regardless of the manager’s own skills. As I’m sure you’ve heard, a rising tide floats all boats.
So working out which funds are likely to perform well in the future is much harder than looking at which have done well in the past. These funds are managed by professional fund managers who will be monitoring the underlying investments. Essentially, they’re taking away the stress of you having to manage it yourself – which is why a lot of people do go down that road.
Should I invest in shares?
Shares are another very popular choice when investing. When you buy shares, you’re effectively buying a small stake in a company. Companies sell shares to investors to raise money to expand and grow their business.
Investors in shares are known as shareholders, who are free to buy and sell their shares on the stock market at any time. If the company performs well or is expected to, the demand for its shares will increase, pushing up its share price. If the company does badly or is expected to, its share price will generally drop.
Interest rates in the wider economy can also have an impact on share prices. As a shareholder, the value of your investment rises and falls with the share price. So while the money you invest has the potential to grow, it could also fall in value. You may get less back than you’ve invested.
What are bonds?
The other asset class is bonds and they’re very commonly used by investors. Fixed income or fixed interest investments and bonds are issued by governments and corporations when they want to raise money.
By buying a bond, you’re giving the issuer a loan. They agree to pay you back the face value of the loan on a specific date, and they also pay you periodic interest payments along the way. These are known as a coupon. Usually you receive your coupon twice a year.
Bonds can be a really good choice when you’re looking for an investment that’s less risky than equities. That said, bonds aren’t risk-free. Unless you’re buying a guaranteed bond, there is a chance you won’t get back what you originally paid.
Investing in bonds as well as other types of investments could be a good way to lower the overall risk of a portfolio. Bonds tend to behave differently to equities, so they can spread the risk. Historically, bonds have been less volatile than equities, but there are more risky types. Long term and high yield bonds can be even more volatile than some equities.
Bonds can give you a steady, defined income as you’re going to get that fixed level of interest twice a year. Bonds are often used in pension investments as people get closer to retirement, because they’re income-generating.
Is property a good investment?
Most people are familiar with property investment, but there are added headaches that come with it. You have to manage that property portfolio and you have to manage tenants. It’s not for everyone.
Can I invest in cash?
You could also hold cash investments in an easy access or a fixed term deposit account. You could have a cash ISA. You could find a bank offers you an annual interest rate to deposit your money with them for a set period of time – usually one to five years.
As you will probably be aware, at the moment we’re in a high inflation, high interest rate environment [podcast recorded in July 2023]. Many banks are offering rates of above 5% for a cash deposit account.
That’s great news for savers – but not such good news for those of us with mortgages.
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Whenever you choose to seek an advisor we will help you get into a better financial position than you are today.
What are the benefits of investing?
Investing is more than building up savings for a rainy day. When you’re saving, you’re setting aside part of your income for tomorrow. Investing is putting your money to work, to potentially earn a better return over the longer term. It’s sending money away for a longer time.
The different classes of investments we discussed earlier typically generate different levels of return. When we compare historic returns over the past 30 years, growth assets such as shares and property have had the best returns of all the asset classes. But they’ve also had bigger peaks and troughs.
As an investor there is the potential to earn capital growth over the long term, as well as an ongoing income from dividends, shares or rent from your property. Defensive assets like cash have not generated the same level of returns over time. But those returns have been less variable, with smaller peaks and troughs.
So for your savings to grow in real terms over time, they need to earn a rate of return after tax that’s greater than the rate of inflation. By investing our money we’re trying to beat inflation.
Another benefit of investing is to earn additional income through growth on your investment. That could help with day-to-day living, or you might choose to reinvest the money to grow further.
Life is always changing, and you can design your investment portfolio to achieve different goals as you go through life. Some people prefer less risky options as they get older and you can tailor your portfolio to reflect those changing goals and priorities.
If you plan on investing over a long period of time, you may want to invest in funds that have good growth potential and are in the riskier sector – emerging markets or private equity for example. Over the long time your money can ride out short-term market changes. But when approaching retirement, you may prefer to invest in more income focused options.
What are the disadvantages of investing?
If you’re not knowledgeable in this area, do seek financial advice. There’s many different types of investments and a financial advisor will help ensure that the type of investment you choose is suitable for your goals and objectives. We will match your attitude to risk on your capacity for loss.
You’ll always hear that past performance is not a guide to the future. When investing in the markets, there is a risk that you could lose some of the capital invested. If there is a broad market drop, your fund’s value will dip with it.
The diversification of most funds will protect you when one or two securities fall, but not when the whole market takes a downturn. That’s happened a few times in recent years – the pandemic, Brexit and the Ukraine war have all impacted on the global markets. Many existing investors have seen the value of their investments drop.
Funds can fluctuate up and down – it will happen, but it shouldn’t deter you from investing or scare you out of the market.
There isn’t a guaranteed rate of return and no certainty that your investments will be higher than the amount you originally put in. The timing of when you decide to take money out can have a big impact on the profitability of your investment.
Another downside of investing is reporting your gains or losses to HMRC. Some people aren’t aware that they need to report on their investments. Some investments can have an impact on tax – so managing investments can be seen as a disadvantage for some investors who struggle to keep track of it all.
How can a financial advisor help if somebody is looking to invest?
To grow our wealth it makes sense to have more than one source of income. In addition to your salary from our nine-to-five job, using investments could be an easy way for us all to achieve this.
Making a conscious choice to pay ourselves first from our salary and investing for our future is an absolute must, in my opinion. As I pointed out when talking about the disadvantages of investing, there are pitfalls – but you can easily avoid these if you bring in an expert from the start.
This is where your financial advisor will really get to work. We will create a financial plan to suit your specific objectives. We also make sure you choose the right investments that suit your goals. We help select the funds that will make up your overall portfolio. Having a trusted advisor to guide you on your investment choices will help you get on the right track.
Your circumstances may change, but we’re there to support and guide you through that. We help you with any changes to the investments, for example as you’re approaching retirement or seeking to draw an income to cover the costs of your child going to University.
An advisor will ensure that your investments are within the right tax environments for you, be it an ISA, pension or general investment account. Different investments are taxed in different ways and at different rates, so an advisor will help to keep you right when it comes to taxation.
Your risk profile is based on your attitude to risk. Alongside attitude to risk we also have a ‘capacity for loss.’ It’s not uncommon for someone to have an adventurous outlook on investing, where they are willing to take a gamble, but in reality their capacity for loss means that their investment strategy is better suited to that of a cautious investor.
The opposite can also be true – so having an advisor to explain the rationale behind that and help you choose the appropriate investments will give you a head start on realising your end goal. We’re here to make sure your money works as hard as you do.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.
