If you’re fed up with low interest rates on savings accounts, you may consider investing. Where should you start if you want to beat inflation and should you invest?
Why are you saving?
The first question to ask yourself is why you’re saving in the first place. If you’re saving money to stop yourself from spending everything you earn, the interest rate you get on your savings isn’t so important. Of course, you want to generate a return but the real benefit to you will be the fact you have money in the bank when you need it.
Ask yourself; are you saving to:
– Set aside some money for an upcoming expense: This can be something short term, such as a new car or home improvements to something you’re saving for over several years, such as a deposit for a flat.
SAVVY TIP: If you’re saving for an expense that you’ll have to meet in the next few years don’t even think about putting your money into share-based funds as you’re likely to be taking on too much risk. It’s not necessarily a problem if the stock market goes up and down but it is if you have to cash in your shares when the market is at a low level. Most financial advisers reckon that the minimum period of time you should invest in share-based funds for is ten years.
– Provide yourself with an income: you may have money in savings accounts where you’re using the interest to live on. If that’s the case you may find yourself dipping into your capital to make up the shortfall.
SAVVY TIP: Keeping your money in savings accounts is likely to mean it will be eroded by inflation. Investing it could mean you get a better return but the risk is higher.
How much risk can you take?
Risk is such a subjective word. What’s low risk to you might be high risk to me. What’s important is that you’re honest with yourself about how much risk you feel comfortable taking on and that your independent financial adviser (if you’re using one) listens to what you say and doesn’t try and pressurise you into doing something you’re not comfortable with.
– Ignore the jargon around risk. Some financial advisers talk about cautious, balanced and adventurous investors. Human behaviour is such that many of us pick the middle option of three choices. Focus instead on the value of your money. Would you worry if you invested £10,000 and it fell in value to £7,000 after two years? Would you worry if it lost £1,000 in value? Would you be relaxed about it if you didn’t need the money for another few years?
SAVVY TIP: Investing in the stock market doesn’t have to be all or nothing. If you think you could handle the idea of investing £5,000 in share-based funds but not £10,000, that’s fine. You don’t have to invest it all in one lump sum (in fact, you may be better off drip-feeding it over a period of months).
– Understand that some funds are much riskier than others. There are thousands of different investment funds around from those that invest in a wide range of shares in UK-based companies to those that buy shares in companies based in Latin America or Asia.
SAVVY TIP: Funds that generate an income through the dividends that certain companies pay (traditionally utilities, banks, pharmaceutical and healthcare companies) tend to be less risky than some share-based funds. However there’s a big difference between ‘less risky’ and low risk or risk free. Make sure you’re comfortable with what you’re taking on.
Choose your investments carefully
If you do think that investing is for you, be prepared to do a fair amount of research into the funds you put your money into – there are lots of resources online – or talk to an independent financial adviser.
– There’s a huge difference in how shares perform depending on how long you can invest for. According to Barclays Capital Equity Gilt study, which compares how well shares have performed compared to gilts (which is the name for government bonds) and savings accounts, shares have produced an average annual return of 4.6% after inflation has been taken into account over a 20-year period. Over five years that falls to 3.3% a year.
SAVVY TIP: An annual return of 3.3% may not feel like much but over the same period, according to Barclays Capital, cash would have generated an annual return of 1.6% after inflation over 20 years and zero over five years.
– Pick your fund or funds carefully. According to the information website Trustnet, funds that invested in companies based in the Asia Pacific but excluding Japan produced the best return over five years (of 105% over the period) while funds investing in Japanese smaller companies would have lost over 25% during the same five year period.
SAVVY TIP: It’s not just how well or badly a fund performs that affects your return but the level of charges. Sometimes funds with the lowest charges aren’t the best option (there’s a difference between something that’s cheap and something that’s good value) but you certainly don’t always get a better fund because you pay higher charges. Funds that track something like the FTSE All Share index (called ‘passive’ or ‘tracker’ funds) are cheaper than those where a fund manager decides which shares to buy and sell. Sadly, many fund managers don’t do any better than tracker funds.
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