Essential rules for first-time investors

Investing in the stockmarket for the first time can be a daunting, not to mention confusing, experience. While all investors always run the risk that the value of their investment could go down as well as up, novice investors face an even greater challenge.

From deciding whether to put your hard-earned money into a tracker fund, an actively managed fund, a multi-manager or a combination of all three, the thousands of different funds out there and wide range of different fees and charges involved can make many novice investors feel out of their depth before they even begin.

Current volatility in the global economy has not helped matters. Gloomy headlines and even gloomier trading reports have hit share prices hard, yet despite the onset of the credit crunch, investing in the stockmarket is far from a recipe for disaster.

According to figures from Lipper, over a 10-year period to the end of June 2008, the average instant access savings account grew by 16.81%. Compare this with the 39.94% return if you had invested in the average UK all companies fund and the message is clear – if you have money to spare, then investing in the stockmarket is the way to go.

Calculate the risk

Before you decide where you want to invest your money, it’s vital you weigh up the amount of risk you are prepared to take. After all, because we all have different goals when investing, your level of risk will depend on factors such as your age, how much you want to invest, what you are investing for, how long you want to invest and what sectors you want to invest in.

Many novice investors unfortunately make the mistake of following fashion and picking the current top performers. A word of warning however - last year’s winners will seldom be this year’s success story, as those who had their fingers burnt investing in the dotcom boom in the late 1990s will testify.

Matt Pitcher, an independent financial adviser at Towry Law, urges caution. "Novice investors often don’t realise that many investment managers who come top one year languish in the fourth quartile the next," he says. "It’s always a big danger chasing performance."

More recently, the biggest boom sector has been emerging markets, made up of funds investing in companies in fast-developing countries such as Brazil, Russia, India and China, the so-called BRIC countries. These economies have performed well to date and the long-term growth story is good, but they are volatile, making them a high-risk investment.

Traditionally, UK equities have proved a sensible investment for novice investors, as many of these funds invest in blue chip and medium-sized UK companies with solid growth prospects, however given the current volatility in the market it could be worth looking further afield.

"We would always suggest a novice investor, with no experience of the UK’s ups and downs, have a spread of asset classes such as global equities," says Pitcher. "This strategy can reduce the risk of volatility and shield their money from any downturn in the markets."

Once you have decided how much you want to invest and in what sector, the next big decision novice investors need to make is whether to choose a tracker or an actively managed fund. Index tracking funds are known as passive investments, and have become one of the most popular ways to invest in the stockmarket.

Investment selection is carried out by a computer to mirror the performance of a given index, so if the index rises, so does the value of your fund and vice versa. Actively managed funds on the other hand, are funds that are run by a fund manager who picks and chooses which stocks to buy and sell, with the sole aim of outperforming the market.

These funds rely on the skill of their managers, who scour the entire market for under-researched investment ideas while trying to control risk.

One of the most heated debates about investment funds is on the relative merits of choosing a passive over an actively managed fund. Passive funds can be a good starting point for those dipping their toes into the stockmarket for the first time, as they combine an easy to understand approach with lower charges than many actively managed funds - most have no initial charges and cost less than 1% to run every year.

They also take the guesswork out of the market because instead of trying to beat it, they join it. "Trackers make a good base for a portfolio to which investors can then add actively managed funds investing in particular areas," says Gavin Haynes, managing director of Whitechurch Securities. "It’s also important to remember that a large proportion of actively managed funds fail to beat the index over the longer term, and only a handful do so consistently."

However, there are several drawbacks to tracker funds. While they may provide a good deal in rising markets, when a bear market begins to bite trackers often slip down the fund performance league tables. They also have no flexibility to move into more defensive stocks to protect their investors’ capital, unlike an actively managed fund.

Actively managed funds also have the potential to dramatically outperform trackers, especially with volatility in the world’s stockmarkets increasing so substantially over the past year. "Fund managers that beat the market consistently do exist," says Philip Pearson, an independent financial adviser at P&P Invest.

"They should be strongly considered in times of volatile markets and can really add value to a portfolio over a medium to long term." The trick, of course, is making sure you choose the right one.

Diversify, diversify, diversify

With volatility in the world’s markets increasing so substantially over the past year, the ability of investors’ portfolios to absorb the impact of stockmarket slumps has never been more important. As such, many investors have been looking to make multi-manager funds the core of their portfolios. Here fund managers invest in a range of other funds, rather than individual companies which means that investors get exposure to a bigger range of sectors and stocks, which in turn reduces risk.

The fund manager will also ditch funds if they start to tumble and switch holdings to make the most of the prevailing economic conditions. In addition to offering diversification in an instant, multi-manager funds also give novice investors access to fund managers they may not otherwise have access to, as well as the ability to invest in areas of the market only available to professional investors.

However, multi-manager funds don’t come cheap – initial costs vary between 0% and 5.5%, while annual charges can be up to 2%. Nevertheless, recent research suggests that investors can really profit from the multi-manager approach over the long term. According to Investment Life & Pensions Moneyfacts, around 60% of global growth multi-manager funds have delivered top quartile performance within their sector over the past 10 years.

"Diversification through a multi-manager fund helps to reduce risk and volatility for novice investors with less stomach for a rollercoaster ride," says Richard Eagling, editor of Investment Life and Pensions Moneyfacts. "The diversification offered by multi-manager funds in today’s economic climate has certainly made them a particularly popular choice among those investors looking to sleep easier at night."

However Philip Pearson believes that multi-manager funds may not be a sensible choice for a first-time investor. "Adequate diversification can be achieved with a multi-asset fund which invests in a spread of asset classes, without incurring the additional expense of the multi-manager approach."

Regardless of the type of fund you go for, it’s always worth making sure you hold it in a stocks and shares individual savings account. Each year you can invest up to £7,200 a year tax-free in stocks and shares, or £3,600 with the remaining £3,600 in a cash ISA. The good news is that every penny earned in interest is free from the taxman’s grasp. The majority of funds can be held in an ISA and accept regular contributions from £50 a month upwards.

Thanks to something known as ‘pound cost averaging’ saving little and often can be less daunting than investing a significant lump sum and helps remove some of the worry when markets fall. This is because when markets are falling and prices are lower, your money buys you more shares, leaving you better positioned to profit when prices start climbing back.

When choosing your fund it is important to consider the charges you’ll pay the investment company for running the fund. If you go direct to an investment company you will pay an initial fee and an annual management charge, which could be 3% to 5% of your initial investment, with an AMC of up to 1.5%. This can work out expensive but the good news is you can cut this cost by buying from a discount broker or fund supermarket.


Discount brokers, such as Hargreaves Lansdown, Bestinvest and Chelsea Financial Services are essentially intermediaries that place your money for you. They often have a small or no initial charge and reduced annual management charges. "We offer a wide variety of funds and most investors will pay little or no initial charge," says Ben Yearsley, an investment manager at Hargreaves Lansdown. "We also rebate a small part of the annual management fee too."

Fund supermarkets on the other hand, such as Interactive Investor, offer an extensive range of investments with competitive fees and charges, meaning investors can spread their ISA allowance across a number of funds. Investing online is quick and easy, and, because funds can be filtered by provider, sector, performance yield and risk rating, it’s reasonably easy to narrow down your choice.

"As all investments can be consolidated in one place, investors can monitor the performance of their portfolio against certain benchmarks," explains Rebecca O’Keeffe, head of fund management at Interactive Investor.

Unfortunately, although discount brokers and fund supermarkets make it easier for you to manage your investments, and offer a degree of guidance, they do not offer specific advice, so doing your research is crucial should you choose this route. If you are uncomfortable with selecting and monitoring your own investments, or you have a significant sum to invest, contacting an independent financial adviser would always be a sensible move. To find one near you, go to or call 0800 085 3250.

Investing in the stockmarket is always a risk - there is no guarantee that your funds will do well, and there’s always a chance that you will lose money. However, history has repeatedly proved that if you have time and can afford to tie up your money for five to 10 years it’s worth investing in equities. There may be ups and downs along the way, but you should be better off in the long run.

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