Why do you have to dip your toe into the stock market before you start?
By swotting up on the markets and getting under the skin of some of the different types of thing you can invest in, you can maximize returns. Nor do you need to make soar-away returns every year to start building up a handsome savings pot.
If, for example, you put away £100 a month and get an average return of 6 per cent a year over 20 years, you’ll have built up a nest egg of £45,600 — almost double what you’ll have paid in. With a good, well-run investment fund (it doesn’t even have to be the very best), you could do better still.
Don’t forget to spread your risk
Generally, investing means using your money to back something which you think will give you a profit.
Most simply, this means putting your money into shares issued by companies that are listed on the stock market.
If the firm does well, its share price increases and you make money. So if you buy a share for £1 and sell it for £1.20, then you have made a 20p profit — in other words, a 20 per cent gain.
But with all investing there is a risk. If that same company does badly and its share price tumbles to 80p, you’ll have lost 20p for every share you own.It is for this reason that buying shares in just one company can be risky. Properly researching and picking individual shares is also a time-consuming endeavour.
That’s why many investors tend to hold shares with investment funds. These put your cash into a basket of companies, thereby spreading the chances of share price rises and falls.
Funds can also be used to buy into other assets, such as bonds, property or commodities. The cost of buying into a fund or selling out of it always reflects the value of the underlying assets it holds – they are known as open-ended investments and if investor money floods in they must buy more assets, or if investor money rushes out they must sell.
Their lesser-known rivals are investment trusts. Like a fund these have a manager who follows a set strategy and buys a basket of shares or other assets. However, investment trusts are traded on the stock market and have a share price which can be different to the value of the investments it holds.
The crucial difference between them and funds is that investment trusts are listed companies with shares that trade on the stock market.
They invest in the shares of other companies and are known as closed end, meaning the number of shares or units the trust’s portfolio is divided into is limited. Investors can buy or sell these units to join or leave the fund, but new money outside this pool cannot be raised without formally issuing new shares.
Investment trusts can be considered riskier than unit trusts because their shares can trade at a premium or discount to the value of the assets they hold, known as the net asset value.
For example, a trust’s price can fall below the total value of its holdings, if it is unpopular and people do not want to invest but do want to sell, thus pushing down demand and driving up the supply of its units for sale. This gives new investors the opportunity to buy in at a discount, but means existing investors holdings are worth less than they should be.
What is your prime target?
Before you start, you need to ask yourself why you want to invest. Are you saving for your child’s future? Is it a rainy day reserve? Or are you hoping to build up a pot of money to supplement your income in retirement?
The answers will help you figure out where to put your money – not least because you’ll know how long it will be invested for. As a rule of thumb, the longer you can keep your money tied up, the more risk you can afford to take.
If you suffer steep or sudden price falls, being invested for longer means you give your cash a greater chance of recovery. And taking more of a gamble also means you have the chance of bigger profits.
You also need to work out if you are investing to generate an income – because some funds will pay you a bonus, called a dividend, which you can receive regularly to spend. If you don’t need an income, then go for a growth fund, which swells your pot of money each month.
Hundreds of specialist funds will help you achieve these aims – and we run through many of them over the page.
A few words of warning. You don’t need to stick to the UK, but the further afield you go, the more risky it can be. If you have debts and little spare cash left over each month, then your focus should definitely not be on investing. And if you don’t already have a rainy day pot of cash sitting in a high street account, then build up this first, too.
Once you have got a solid base to start from and are willing to take a little risk with your nest egg, then you are ready to invest.
Don’t be over-zealous
Take it steady to start with and don’t be tempted to tinker all the time. If you’re over-zealous, this could lead to you panic-selling your funds if they’re not doing that well in the short-term. Selling when your fund has gone down means that you have lost money. Instead, you should wait and give it time to go up again.
Figures from fund manager Fidelity show that £1,000 invested in the stock market in 2004 would have grown to £2,264 by the end of January 2014 if investors just left it where it is. But if you dipped in and out and missed the ten best days by trying to second-guess the market, you’d have made only £1,236.
Once you’re up and running, check your fund once a year – and if you notice after at least two years that it’s one of the worst performers compared to its peers, then it’s time to move your money.