How does investing differ from saving?
You’ve probably been told many times that to get rich or make your money work harder, you’ve got to invest. But what does that really mean? And how does it differ from regular saving?
While setting money aside in a standards savings account is a great way to build up an emergency fund or save for short-term financial goals, such as a holiday or a wedding, the funds are unlikely to grow much due to low interest rates.
At present, most banks are offering interest rates on standard savings accounts of less than 1.5%, though there are some exceptions.
However, if you were instead to invest your money in the stock market or other investments, you could earn a return equal to multiples of that. The downside?
Well, your money is at risk and you’re therefore not guaranteed to get back as much as you originally invested. Hence, you’d need to make sure you’re both willing and able to take the risk associated with investing before getting started.
What can I invest in?
While most people think of the stock market when it comes to investing, the options available are wide-ranging and also include bonds, funds, property, gold, oil, art, small businesses and more. Each investment type (also called asset class) differs in important ways, notably in terms of risk, return and how easy it is to buy or sell that investment (liquidity). They also behave different depending on the broader economic and political environment.
How much should I invest?
When working out how much to invest, the answer is similar to saving – as much as you can afford and are willing to risk losing if it all goes south. While the answer will differ from person to person, as with savings, small amounts invested regularly add up over time.
For example, if you were to invest £200 a month for the next three years and earn a return of 4.5% (which Aviva associates with medium risk), your growth would be £420.43, in contrast to £82.31 if you earn a ‘low’ return of 1.5%. This includes a fee of 0.75%.
While past returns are no indication of future returns (as many financial advisers and disclaimers will tell you), the example shows you the power of investing.
While lots of factors ultimately impact the outcome of any investment, it’s a good idea to understand the most popular types of investments out there and how they tend to behave depending on the economic and political environment.
What can I invest in?
The main investment products to be aware of (and which you might find useful to research further!) include:
Stocks and shares
Stocks and shares essentially refer to the same thing (and are also known as equities), though the former tends to be used more in America. When you’re buying a share or equity, you’re buying one small slice of ownership in a specific company.
The company is under no obligation to return the funds you spent on the share to you, but you may receive dividends (regular payments out of the company’s profit), and you can buy or sell the share to another investor.
If the share price rises (e.g. due to higher profits), you will make gains, and likewise, if it falls you make a loss on your investment.
In theory, the share price could fall to zero (meaning you lose all your money invested in that share), or it could rise infinitely.
It’s important to remember that the gain or loss only becomes reality (realised or crystallised) once you actually sell the share. Before that, any price movement is only on paper – though it could lead to tax implications regardless.
Bonds
Bonds are similar to an I-owe-you or a loan to a company or government.
If you buy a bond, you’re effectively lending money to the borrower, which you expect to receive back at the end of the term of the bond, as long as the borrower does not default (e.g. if they go out of business) in the meantime.
Your return comes from any interest payments you receive, along with any potential changes in the bond price between the purchase and sale (or maturity) date.
Funds
For those who don’t fancy choosing individual stocks and bonds to invest in (which can be both time consuming and inefficient for inexperienced investors), funds may be a helpful alternative.
There are different types of products which people associate with ‘funds’ (e.g. mutual funds or ETFs), but the common characteristic is that they offer investors the opportunity to invest in a range of securities, e.g. US stocks or UK bonds.
Funds may track a specific index or be managed in a more discretionary way by a professional investment manager, who picks and chooses what to put in the fund, based on general guidelines. Index funds seeks to perform in a similar way to indices, such as S&P500 or FTSE100.
If you decide to go down this route, be sure to read the investment product information as this will give you insight into the investments included and allowed within the fund and the associated risks to be aware of.
Real estate
Property investing tends to be popular as people feel like they can relate to it, given that it’s a physical asset that serves a functional purpose.
When you buy a property specifically with the intention of renting it out, you’re a buy-to-let investor.
This comes with a host of tax rules which have changed in recent years in the UK, making this an increasingly less popular option for many investors.
A different way to get involved in property investing is to buy shares in a property investment fund, which in turn is managed by a professional property investor.
The fund may invest in different types of properties and regions, so it’s worth making sure you read the terms and conditions!
Alternative investments
This is a bit of a catch-all bucket for investments which don’t fit into the typical categories above. This could include investing in hedge funds or start up companies, or peer to peer lending (such as Zopa or Funding Circle). These investments can be appealing from a diversification perspective (which means to spread your risks across different types of investments which don’t usually fall or rise at the same time), but can also be deemed riskier.
How do I physically get started with investing?
So, you’ve decided you want to invest and how much. But how do you actually get started with investing?
There are lots of ways.
The first step is to open up an investment account with a digital platform or a bank.
Financial advisors can help you, though this is typically an option reserved for those with a large pot of money to invest. For newbie investors, it makes sense to take advantage of any tax-efficient investment accounts available (e.g. a stocks and shares ISA in the UK, or your pension).
How do I choose what to invest in?
Make sure you research your options carefully so that you are familiar with the risks and returns to expect from your investments.
A good place to start is by reading the business section of your favourite newspaper, personal finance websites (such as this one!) and any literature you can find on your chosen platform’s website (or that of its competitors).
Arming yourself with knowledge will ensure you go into your investments with your eyes wide open.
You may also find it interesting to read about what other star investors are advocating, such as Warren Buffet.
If detailed investment research isn’t your thing and you can’t or won’t pay for a financial advisor, you can try a cheaper digital alternative, such as a robo adviser, an online wealth management service that invests for you – see Putting Robo Advisers to the Test for more.
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