Six tips for reluctant investors
While the volatility of recent weeks may have caused concern for some new investors, analysis provides a compelling argument for investing over the medium to-long term. Data shows that the FTSE All Share Index outperformed cash by 32.99% over the last five years and 123.72% over the last ten years.
Everyone's attitude to risk differs, but those with a medium to long-term investment time horizon should still be considering stocks and shares in order to benefit from the superior returns offered by equity and fixed income markets and to protect their savings against the impact of inflation.
While cash may feel like the safest option, especially when markets are volatile, with interest rates likely to remain low and inflation stubbornly high, it will offer very little opportunity for savers to grow their hard earned money or even to maintain its purchasing power.
With such a wide universe of possible investments to choose from it is difficult for investors to fully research and understand all the many companies with shares quoted on the stockmarket. Understanding the complex world of government and corporate debt is even trickier.
Funds managed by experienced investors and backed by a large team of experienced analysts give investors the opportunity to invest in the shares or bonds of a wide variety of companies without having to do all the legwork themselves. Be realistic about your ability, and more important, willingness to devote the time to being a successful investor on your own.
Don't try and time the market
Saving small amounts on a regular basis can help to combat the natural tendency of investors to sell when markets are low and buy when they are high. It is extremely hard to establish when is the best time to buy and sell shares and funds as the speed at which markets react to news means stock prices very quickly absorb the impact of new developments.
This means investors who try to time their entry and exit are likely to miss the bounces. One way investors can avoid the temptation to time the markets is to set up a monthly savings plan. Data shows that investing £1000 in the FTSE All Share 15 years ago could have returned £2,005 but if investors tried to time the market and missed the best 40 days the same investment would only be worth £363 today.
Don't follow the herd
When considering where to make your first investment following the trend isn't necessarily the best strategy. The top-performing assets one year can continue to do well or drop to the bottom of the list. There is no way of predicting which it will be.
The performance of different asset classes over the past ten years shows how dangerous it can be to believe that the market's best performers will continue to be so. In the ten years from 2003 to 2012, for example, property was the best-performing asset classes on six occasions and the worst on two others others.
Other asset classes like shares and bonds also bounce around within the performance tables. Unless savers think they can devote the time to study the markets in great detail, a multi manager or multi asset funds is often a wise choice.
Don't put your eggs in one basket
Piling all your money into one asset class or into one geographical area can be very dangerous if markets fall. For example, the Chinese stockmarket has been very weak over the past year while the Japanese market has soared and the US and UK markets have performed relatively well. Investors should spread their investments across multiple asset classes from equities to bonds and across different regions from the UK to Asia and the US.
Remember the power of dividends
Some companies pay a slice of their profits twice a year to investors. These dividends can be spent as they are paid or reinvested back into the market. The power of compounding this income is what makes equity investments so attractive and over time dividend income provides the lion's share of the total return from an investment.
The FTSE 100 index is at roughly the same level it was at in 1999 but if you'd put money in shares and reinvested the dividends the total return over that period would have been significant.
Protect your savings from the tax man
When putting money away to achieve your goals it is important that you keep as much of it as you can and protect it from the tax man. Investments may produce an income and increase in value. The profit you make from any capital growth is generally subject to capital gains tax if it exceeds your annual tax-free allowance (£10,900 for tax year 2013/14).
If these investments are inside an Isa, a tax efficient wrapper, there is no further tax on any of the income you receive and in addition, you pay no tax on capital gains arising from your Isa investments. You do not even have to tell the taxman about your Isa investments.
Tom Stevenson is investment director at Fidelity
This feature was written for our sister website Money Observer
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.
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).
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).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
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.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.