10 tips for beginner investors
1. Investing isn't just for high rollers
You don't have to have Warren Buffett's bank balance to dabble on the stock market. Most investment funds will accept monthly deposits of £50 or lump sums of between £500 and £1,000. You do, however, have to be able to stomach watching your savings fall in value as well as rise.
Investing is a long game, so you must be prepared to lock your money away for a minimum of five years, ideally a decade or more. It is therefore best suited to those with long-term financial goals, saving for retirement or a child's education, for example, rather than a house deposit or a new car.
2. Beware reckless caution
Gambling your money on unpredictable markets can be nerve-wracking. But history has repeatedly shown that over the long term equities outperform cash savings. This is hardly surprising when you consider the pitiful returns offered by banks and building societies on savings accounts at the moment. For more on this topic, read Moneywise columnist Jeff Prestridge's advice on how saving cash is a poor choice in the long run.
The average long-term fixed cash Isa pays just 1% interest, according to financial website Moneyfacts. That is less than the current rate of inflation of 1.6%, meaning that the majority of cash savers are actually losing money in real terms.
3. There are tax advantages of investing
Savers are entitled to an annual tax-free allowance of up to £15,240 this tax year on money invested through a stocks and shares Isa. From 6 April, this allowance will rise to £20,000.
You do not pay capital gains tax on any income earned or interest paid on investments made through an Isa. You will also pay a flat rate of 10% on any dividends, which benefits higher-rate taxpayers in particular as they would otherwise pay 32.5%.
4. Think about what you want to invest in
Cash is traditionally seen as the least volatile asset class. Your money is safe and protected by the Financial Services Compensation Scheme in the event of a bank or building society goes bust. But as shown in point two, its buying power can be eroded by inflation so you end up losing money in real terms.
Fixed interest investments, which are loans to companies (in the case of corporate bonds) or governments (known as government bonds or gilts), provide modest but reliable returns and are traditionally regarded as lower risk than equities. You can invest in this sector via bond funds.
Shares, also known as equities, offer a stake in a company. Shares tend to rise in value when a company does well and fall when it does not. For more information about shares read What is the stock market?
5. Don't put all your eggs in one basket
If you funnel all your hard-earned cash into shares in one company and the company tanks, you will lose it all. The idea is to 'diversify', which involves dividing up your lump sum across a portfolio and investing portions into varied companies, asset classes or global markets.
As some markets fall, others will rise and cancel out losses. How you spread your money will be led by your attitude to risk. Cautious investors shouldn't have too much in equities.
Read more about not having all your investment eggs in one basket.
6. Think about investing through a fund
You can buy shares directly but this can be expensive, difficult and risky. For a beginner, it's usually better to invest through a collective fund, which offers an affordable way to buy up lots of different assets without the responsibility of making your own investment decisions. In the most popular type of investment fund, such as a unit trust or open-ended investment company (OEIC), you buy units and your money is pooled with others.
A fund manager then uses their expertise to buy and sell shares (or bonds) on your behalf to maximise returns for investors. There is a charge for investing in funds, but because you are spreading the cost with your fellow investors, it works out much cheaper than it would be for you to invest in the same shares yourself.
7. Spend time choosing the right fund
There are thousands of investment funds, so you need to do your homework to pick one that meets your financial goals and suits your appetite for risk. The funds invest in more than 30 sectors, categorised by asset class (equities, say, or fixed-income); geography, for example UK small companies, or Asian emerging markets; sector type, such as technology or property; and investment style such as growth or income.
Monitor the performance of a fund over a period of time, five or seven years, rather than just looking at whether a fund did well last year. Remember you are playing a long game.
To help you narrow down the choice of funds, Moneywise has produced its First 50 funds for beginners.
8. Consider passive or tracker funds
Passive or tracker funds, which mirror or 'track' the performance of global stockmarket indices, are not run by managers but by computers. As a result, they are much cheaper. The jury is out on whether passive or 'active' funds – those run by a manager – produce better returns over the long term. To find out more read our head to head debate on active vs passive investing.
All trackers charge a management fee, so they are guaranteed to underperform the market they follow. But costs are low, as little as 0.15%, so the return you get will pretty closely match the index. By comparison, most active funds 0.75% or more. Your returns therefore need to at least equal that if your fund is to stand still.
- Read more about the importance of keeping charges low.
9. Buy through a DIY investment platform to save money
Unlike opening a savings account, investing in a fund costs money. Buying your units directly from a fund manager is the most expensive option. It is cheaper and easier to buy through a fund supermarket or platform, which lets you hold, manage and review all of your investments in one place. DIY investment platforms, from companies such as Hargreaves Lansdown, Interactive Investor or Bestinvest, charge either a flat fee or a percentage of your investment.
For smaller investors, the cheapest is usually a platform that charges the lowest percentage-based fee. If you are investing a hefty sum, you are probably better off with a flat fee.
10. Invest regularly to minimise losses
It is impossible to pick the perfect moment to invest to beat the market. Improve your chances of maximising your returns by drip-feeding your money into a fund on a regular basis, for example once a month, rather than investing a lump sum in one go. This is known as pound-cost averaging. You buy fewer shares if you catch the market when it is rising but you can buy more at cheaper prices if it is falling, averaging out the overall cost and risk.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.