Getting started with investing — part one

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If you’ve thought about investing but have been put off by the complexity, here are some thoughts on how to get started:

Understanding risk and return – savings accounts

As recent banking crises have shown, there’s no such thing as ‘risk-free’ when it comes to money. But, assuming your money is safe in the bank or building society, it could still be eaten away by inflation. This means:

  • The amount you have in the account may grow (as interest is added) but its buying power is reduced. – because the price of everyday items grows by more.

Understanding risk and return – investing

If you want to invest in the stock market, whether that’s through an investment fund or funds, or by buying shares in individual companies, you’ll have to take on some risk. It’s a different type of risk to the risk that you take if you put money in a bank.

The main risks are:

1. That you lose some or all of the money you invest — permanently.

2. That the money you invest reduces in value; either due to inflation and/or fees and charges.

3. That your money doesn’t grow as you expect.

4. Lack of liquidity – that you can’t get hold of your money when you need to. The more liquid an investment is, the easier it is to get your hands on. So, money in a stocks and shares ISA should be liquid because you can cash it in fairly easily, but money tied up in property is often illiquid because the property may take months to sell.

5. Too much volatility. Volatility measures how much the value of your investments rises and falls. Shares can be very volatile, but bonds (which are essentially IOUs issued by companies or governments) are often less volatile.

The importance of spreading your money around
You may hear investment professionals talking about ‘diversification’ or ‘asset allocation’. These basically refer to the idea of spreading your money between different types of investments to reduce the risk.

  • The more concentrated your investments are, the more risk you’re taking on.
  • Your money should also be spread around different regions around the world. This should reduce the levels of risk.

Invest for the longer term
It’s tempting to invest when you think the stock market will rise and sell up when you think it will fall, but it’s much harder to predict the top or bottom of the stock market than you think. So, it’s better to invest for the longer term. Research by Nutmeg in 2013 showed that:

– Over the last ten years, the stock market made an average return of 9.9% a year (before fees and charges).

– If you missed the ten best days of stock market performance in those ten years, your average return would be reduced to 3.5% a year.

– If you missed the 20 best days, it would have reduced to a loss of 0.3% every year.

– If you’d missed the 30 best days, you would have made an average loss of 3.3% every year.

Photo credit: Morguefile/mconnors

Related articles:

Pound cost averaging: can regular investing make your money go further?

A beginner’s guide to gilts (UK government bonds)

VIDEO: What is a self select ISA?

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