Investing for beginners
Investing your money can potentially generate higher long-term returns than simply saving your cash and earning interest.
However, it also comes with greater risk.
There are no guarantees of success – just tried and trusted ways to approach it wisely.
If you're new to investing, here's how we suggest you get started.
Before you invest
First things first: it's always wise to have a financial plan in place before you invest. With the big picture mapped out, you can work out what goals your investments are going to help you achieve.
Next, there are a few other things to take into account before you expose your money to risk. Every wise investor starts out by checking off key points like these:
1. Your current financial situation: debt and savings
Make sure any debts that you have are under control and that you have enough savings in your ‘emergency fund’, to cover unforeseen demands on your cash flow.
Protection insurance can offer a financial safety net in case of loss of income – through job crisis, poor health or death depending on the type of insurance that you choose.
2. Your stage of life
Your attitude to risk may be strongly influenced by your future plans and your stage of life.
For example, if you need a fixed amount of capital to turn into an income for retirement in a few years’ time, you are likely to be more risk-averse than if you are still 20 years from retirement and relatively commitment free.
3. How long you can give up access to your capital
Investing should be considered a medium to long term commitment. Start with a time frame of at least 5 years, preferably longer. If you think you’ll need access to your capital before that, a cash savings account may be more suitable for you.
4. Your investment goals
Before you invest you should have a good idea of your short- and long-term financial aims. Are you looking to generate a regular income, or do you want to grow your capital? What will you use it for – are you relying on getting back a certain amount in future? What will happen if you don't achieve your aim? Knowing your goals from the outset will help you choose a suitable level of risk and style of investing.
5. Whether you need advice
If you are unsure about the options available or the risks involved, consider getting in touch with a financial adviser before you proceed. Investing your own money requires confidence; some people prefer to have a professional adviser talk through the options and recommend a course of action.
Types of investment
With your financial plan in mind, the next step is looking at the different types of investment available. The main categories (asset classes) of investment are:
- Shares (also called equities)
You can invest in shares and bonds by opening an account with an investment platform.
One of the most beginner-friendly ways to invest in these asset types is through a collective investment such as an investment fund.
About collective investments
Collective investments involve pooling your money with other investors in exchange for a share of a ready-made investment portfolio, managed by a professional fund manager.
This type of investment can provide a useful way to diversify your portfolio across risk levels, assets, and asset classes, if you do not have enough capital or investment know-how to do so yourself.
Collective investments can be actively managed, meaning the manager tries to select investments and outperform a benchmark, or passive, meaning they aim to track a stock market or index.
Names for collective investment include funds (unit trusts and OEICs), investment trusts and ETFs – find out more here.
The costs of investing
There are a number of costs that you may encounter, depending on the type of investment that you choose. These can include fund management fees, platform fees, share dealing charges.
Since many of these costs apply whether your investment performs well or otherwise, they can be a significant factor in your long-term returns. Don't forget to factor in all costs when choosing an investment.
All investments carry some level of investment risk. The nature and type of investment risk varies widely across different investments and asset classes. Generally speaking, the higher the potential reward, the greater the level of risk, and vice versa.
The level of risk you’re comfortable with taking is referred to as your “risk tolerance”. Establishing your attitude to risk will depend on a number of things including your stage of life and goals for the medium and long term.
Types of risk include:
- Capital risk: The risk of not getting all of your money back
- Inflation risk: The risk that your investments will fail to keep pace with inflation
- Liquidity risk: The risk that you will not be able to sell your investment in an emergency without sustaining losses
- Default risk: The risk that a company you are invested in fails to meet commitments to repay money that is due
- Interest risk: The risk that income generated from an investment could fluctuate
- Investment risk: The risk that the value of your investments can go down as well as up
Not all of these types of risk apply to every type of investment. Read more about risk and potential return
Spreading your capital across a range of different investments, known as diversification, can help reduce investment risk overall, because if one investment should fail or not do so well you will not necessarily lose all of your capital.
To understand how to diversify, and why it's important, read our guide to asset allocation.
Protecting your investments from tax
- Stocks and Shares ISAs can provide a “wrapper” to protect your investments from income tax and capital gains tax on your investments
- Pensions can also provide a tax efficient method of investing for retirement.
Whatever type of investment you choose, make sure you research your options carefully and assess all the risks and charges involved before you proceed.
You may have heard the term "execution-only", or "DIY" investing: this means investing under your own direction, rather than following the recommendations of a financial adviser. This can be a low cost way to build an investment portfolio, although it can also carry a greater risk in that you do not have the benefit of professional financial advice to help you choose investments that match your aims and risk appetite.
If you're confident in taking the DIY approach, you can compare and invest in a range of funds through an investment platform such as Hargreaves Lansdown, Barclays Stockbrokers or Interactive Investor.
If you are at all unsure about the suitability of a particular investment, speak to a financial adviser who can guide you through your options and help you choose an investment to suit your needs.
Last updated: 03 June 2015