Published: 31 March 2022. Written by: Laura Whateley
If you’re a beginner to investing, read this before making any decisions about what to do with your hard-earned money
As the cost of living rises, investing your money is a smart idea. Cash lying around in savings accounts paying tiny rates of interest loses value quickly when inflation is so high. In the past, stock markets have produced better returns.
However, there’s lots to consider before you invest for the first time. Here’s where to start
1) You still need some cash
Don’t invest every penny you have. Everybody should have a stash of cash in a rainy-day or emergency fund that you can withdraw in an instant, should you need it.
Charities warn that many of those who get mired in unmanageable debt do so because they had to borrow on a credit card or with a payday loan for an unforeseen event. This could be anything from a car breakdown to paying rent or mortgage after redundancy.
Financial advisers recommend aiming for at least three to six months’ worth of essential bills in an easy-access bank account. This means you won’t need to borrow should this happen to you.
Only once your emergency savings are in place should you consider investing any extra savings to make your money work harder and beat inflation.
2) Investing is a risk – consider your appetite for it
‘While stocks and shares have the potential to generate higher returns than cash, you need to remember that the value of the assets can fall as well as rise,’ says Kim Jarvis, Technical Consultant for Tax and Trusts for Vitality. ‘They are generally geared towards investors with an appetite for risk and a long-term investment outlook.’
In the money world, risk is related to reward. The more risk you take, the greater the reward; and if you don’t take any risk, you can’t expect your money to grow. But you could also lose a lot, too. It’s not guaranteed that by taking a bigger risk you’ll get a bigger reward – if it were, it wouldn’t be risky.
Before embarking on the investment journey, think about how comfortable you would be with your savings shrinking. How would you feel watching your investment nosedive in value on screen? Have you got the confidence and patience to hang in there and watch it creep back up, or would you be tempted to withdraw it immediately? Can you afford to take a bigger punt with a smaller proportion of your money?
Get your head round the ways to reduce risk, too. One of the most important is seeing investment as a long-term venture. Stock markets rise and fall day to day, so you need to be able to hold your nerve.
Stay put for at least three to five years, ideally longer, and you can ride out the inevitable bumps, to make your savings grow instead.
The longer you are prepared to stay invested, the riskier the assets you can afford to add to your portfolio.
3) Always understand what you’re investing in
You can invest in many different types of assets, from cryptocurrency (such as Bitcoin) and NFTs (non-fungible tokens – a kind of asset that only exists in digital form), to more traditional stocks and shares, bonds (essentially a loan to a company) and funds (a managed portfolio of different kinds of assets).
Understanding what it is you are buying, rather than following what other people say is the latest hot investment, is essential to understanding the risk you’re taking with your savings. Only you know how comfortable you are with risk.
For example, when you buy stocks and shares, also known as equities, you are buying a slice of a company, which could be anything from a fashion brand to a sustainable energy provider. The hope is that the company will be profitable and grow, making your slice worth more than when you bought it. Of course, there is also the possibility that a company may shrink, have a few bad years, or even go bust.
Knowing this helps you see that if you are a beginner investor, putting all your cash in one company, buying only their shares, is much riskier than spreading it between several. If that one company has a bad year, all your money is affected. If only some of your savings are in that company, the impact on your savings is smaller.
4) Diversify, diversify, diversify
Diversification, which means spreading your money around different types of investments, is essential.
That might mean having a variety of assets in your portfolio (your portfolio is your collection of investments), or it might mean investing in stocks and shares in different types of companies, based in different industries or different countries.
Politics, economics, climate, how many people on Instagram love (or hate) a company’s product, all have an impact on how well companies and therefore stocks and shares, perform.
An easy way to spread your risk, or diversify, as a beginner is to invest in funds. These are made up of different types of assets (including bonds, stocks and shares, and other types of assets) or companies, rather than buy single stocks.
5) Make the most of ISAs
Like choosing the best bank account, you will need to choose the type of account to hold your investments. When making this choice, bear tax in mind. As with your salary, you are liable to pay tax on income you receive through interest on your savings accounts or dividends on stocks and shares, and on returns like capital gains from selling shares.
The exception is if your investments are held within an ISA. Jarvis explains: ‘You pay no income tax on any interest or dividends you receive, and any returns are also free of capital gains tax.’
You get an ISA allowance of £20,000 each tax year, which runs from 6 April to 5 April, and you can split this allowance across different types of investment, including cash savings and stocks and shares.
The great thing about ISAs is that any money you earn from them is tax-free, forever. So even if you’re just dipping your toe into investing and your savings don’t amount to much, yet, the tax-benefits will last for years to come.