INVESTING FOR BEGINNERS
A Complete Investing for Beginners Guide
With interest rates on your savings accounts at all-time lows, you may have heard people talking about investing in order to try and make a decent return on their money.
But what exactly is investing? How much does it cost? Where do you invest? and are there any risks involved? These are all very relevant questions to an investing beginner, and therefore we have written this detailed investing for beginners guide Just for you. Let's dig in!
What is Investing?
The technical explanation of what is investing is as follows, Investing is defined as the act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit.
In plain English, investing is simply putting some of your money into an asset (more on assets later), then leaving it there for a period of time with the hope or expectation that over that period of time, the original value of your money invested will have increased.
Investing has also been likened to the phrase you can have some jam today, or more jam tomorrow.
The key goal of any investor is to put away money into appropriate assets, and then reap the rewards of those assets increasing in value over time, and therefore generating a profit on the original money invested. That's it in a nutshell.
By way of a quick example here are two scenarios of what you could do with a £1,000 cash windfall.
Example 1. Spend the full £1,000 on something you desire today, for example an expensive cycle, and then you have no cash left but a bicycle.
Example 2. Invest the full £1,000 into an appropriate asset, which we will assume is a stocks and shares fund for now. Leave the money invested for the medium to long term, let's assume seven years in this instance, and then your invested money may be worth £2,000.
So, you now have the choice of what to do with £2,000 as opposed to your original £1,000, although you have had to wait a fairly long period of time for it.
Why do people invest?
People choose to invest for many different reasons, for example they may be saving for a house, a retirement fund, a holiday of a lifetime, or any one or more different reasons. But, they all have the same long term goal of increasing the value of their initial money invested into something more substantial, and potentially and hopefully significantly more substantial.
Here are three key overriding reasons why people choose to invest:
1. Returns on cash are negligible
Although keeping your money invested in cash in a bank may seem like a safe thing to do, you are in fact losing money in real terms, as the rate of inflation, currently in excess of 5% around the world, eats into your spending power. Currently returns from bank accounts are between 0.1% and about 0.5% at best. This means you are guaranteed to lose money by investing in cash.
In order to try and maintain the spending power of your money, some people turn to investing to try and achieve an above inflation return.
2. Over the long term your money can grow significantly
If you left your money in a cash bank account over the long term, say 10 to 20 years in the current low interest rate environment, you would still have practically the same amount as you invested even 2 decades later, But your spending power would have reduced considerably.
However, those who decided to invest that money into appropriate assets and leave it there for the same 10 to 20 years, are likely to have seen significantly more growth than that of a cash account.
Depending on what asset class you invested your money in, it is quite possible that after 20 years of investing your initial investment could be three times, four times or even higher depending on how that particular asset class performed.
It is also possible that it didn't perform so well, and you ended up with less money than you started. We will deal with the risks of investing for beginners in more depth in a later section.
3. The power of compound interest
There are some people who suggested that Einstein called the power of compound interest the eighth wonder of the world, and suggested those who understand it earn it, those who don't pay it.
In very simple terms compound interest can be likened to a small snowball gently rolling down a hill, whereby it slowly to begin with collects more snow and grows.
As the snowball rolls further down the hill, it gets bigger as it collects more snow and goes faster and therefore collects even more snow, and so on and so forth until the snowball is a huge pile of snow.
The same can be compared as to what would happen with a cash pile if it was invested over many many years, and benefited from the power of compound interest, whereby dividends earned, and interest earned on bonds was reinvested time after time, month after month, year after year. You would be earning interest upon interest upon interest!
Compound interest is an extremely powerful tool once you have been running your investment portfolio for many many years. This is an important investing for beginners lesson.
What risks are involved when investing?
It is very important to understand right from the off, that investing is not like putting your money into a bank or cash account. If you put £100 into the bank today you will still get £100 out of the bank in one year’s time two years’ time or five years’ time. It is safe and secure, and even if the bank went bust, the UK or US authorities will guarantee that sum of money for you.
Investing on the other hand does involve risk. To make matters more confusing, there are also different levels of risk that you will take if you do choose to become an investor.
So, let's just come out with the worst possible scenario as an example of a high-risk investment. In plain and simple terms, you could invest your money into a certain asset, and let's call it a single company stock for this example, and for whatever reason that single company ceases trading and goes bust overnight. Therefore, you will have lost your entire investment, be that £100, £1,000 or £1 million.
Novice investors or beginner investors are recommended to start investing in more low to medium based risk assets, such as funds or mutual funds as they are often called. This just means that there are a collection of individual stocks and shares in the fund operated by a professional fund manager, and the chances of all of those going bust overnight are very slim indeed.
That's not to say the price and value of your money cannot go down because it can. But you are unlikely to see a full loss of your money with a fund. Be warned even these funds can lose significant value if the stock market turns against you, for example many funds were 30 to 40 or even 50% down during the initial COVID pandemic market sell off.
As mentioned at the beginning of this investing for beginners risk section, there are different risk levels that need to be considered and it is recommended that beginner investors test the waters with a low to medium risk based investment portfolio to begin with, at least before venturing further up the risk ladder.
What appetite for investment risk do you have?
As mentioned above there are risks involved with investing and there are also different levels of risk involved. So before you commit any money towards your investments you need to take a long hard look at yourself, and ask the question, what appetite for investment risk do I have?
By way of example, if you are the sort of person who wouldn't be able to sleep at night or woke up in a cold sweat at night just thinking about your investments falling by 5 or 10% or a few hundred or thousand pounds, then investing probably isn't right for you.
However, if you understood that investing was a long term game, and that the value of your investments are highly likely to both rise and fall throughout the duration of your investments, and you could also stomach without panicking, significant asset class or market shocks, such as a reduction in capital value of 20-30%, 40% or even 50% on occasions, then investing may well be something you should consider, and then it is just a case of deciding how much risk you wish to take with your investments.
It is also worth being aware of the fact that generally speaking, the more risk you are prepared to take, the higher your potential rewards are likely to be. And the same is also true if you are only prepared to take a low-risk approach then your likely rewards are also going to be lower than some strategies.
Generally speaking, those with longer term time horizons should be fairly comfortable to invest in a range of moderately risky asset classes, as they have time on their side to claw back any losses made in the early years.
Learn more about the risk v reward matrix here.
How do you start investing?
Before you start investing for beginners for the first time, make sure that you don't have any expensive debts you are paying excessive interest rates on, for example credit cards or store cards. If you are paying 25 to 35% Interest on these cards, then you are unlikely to be able to make that money back on any investments you choose.
Secondly, it is wise to have an emergency cash fund somewhere of circa three to six months expenses, in case of immediate emergencies, such as unemployment, the boiler breaking down, or the car needing an emergency repair.
Once the above two considerations have been made, then you can begin your investing for beginners journey by asking yourself the following questions:
What are your medium and long term investment goals?
How long can you leave your money untouched?
Can you leave your investments for between 5 to 10 years?
How much can you comfortably afford to invest?
How much risk are you prepared to take with your investments?
Can you cope psychologically with seeing your assets fall in value and not want to sell out and run for the hills, crystallising your losses?
Once you have considered and answer the above questions, then you are ready to begin investing.
The first thing you will need to do is choose an investment platform which will act as the base for all your future investments.
Nowadays, the easiest and most cost-effective way to start investing for beginners is via something called an investment platform.
Investment platforms are simply marketplaces or online shops where you can choose to buy and sell various types of assets, such as stocks and shares, bonds and funds.
They can also sometimes be called fund supermarkets.
The most common investment platforms in the UK right now are;
Whilst it is usually free to join an investment platform, there is no such thing as a free lunch, and you will ultimately be charged for its ongoing use. See how much does investing cost in the section below.
Confusingly each of the platforms have slightly different fee structures and charging methodologies, and so you need to review each in turn to see which is best value for your own particular needs.
Hargreaves Lansdown is known for containing lots of useful information for do it yourself investors, but the overall platform fee of 0.45% is considered quite expensive.
Interactive Investor has a monthly charging fee that is generally cheaper for larger portfolios, but could work out more expensive for smaller investors.
Fidelity has two different charging fees depending on how large your investment portfolio is. Once your investment portfolio exceeds £250,000 then the platform fee reduces to 0.2% per year.
As we mentioned above, investment platforms are essentially supermarkets for stocks shares and funds, and once you select your investment platform, you will be able to browse and choose anyone of thousands upon thousands of different investment vehicles.
How much does investing cost?
As we alluded to in the previous section, whilst the initial signup of the investment platform is free, there are certain other costs and charges that must be considered.
Firstly, your investment platform provider will charge you a fee for holding your investments on their platform. That administration fee for this service is usually somewhere between 0.2% and 0.45% of your total funds, although it could also be a fixed fee such as £10 per month.
Secondly, you will be charged a buying and selling fee if you are buying or selling individual stocks and shares. Typical fees per transaction are circa £10 to £12.50 on average. There is also a tax charge on some stocks and shares purchases in the region of 0.5% of the value of the transaction.
Thirdly, if you invest in mutual funds or trust funds, then you will also be paying the professional fund manager a fee for the privilege. This can range from 0.1% for low maintenance index tracking funds, and up to 1.5% for some actively managed funds.
Fourthly, there are also other costs that can be lumped into transactional costs that apply to mutual funds and trusts. This is a fee for the buying and selling of individual assets in the fund, and of regulatory fees and the like. Therefore, it is important to look for the TER or Total Expense Ratio as opposed to any other metrics that may be advertised.
For those beginner investors just starting out, make sure you keep a very close eye on the overall fees charged by your platform provider and your fund manager. The difference of just a few points of a percentage over a long period of time can make a huge difference in your overall investment pot. Sometimes to the tune of many 10s of thousands of pounds over a lifetime.
What can you invest in?
The types of investments you can invest in are often called assets. And whilst there are quite a number of different assets that can be traded openly, the main asset classes recommended for investing for beginners are as listed below:
Stocks and shares also known as equities
Mutual funds and trusts
Property based funds
Commodities such as gold, silver, and oil
Beginner investors should only invest in assets they know and understand. You will note we have not listed Bitcoin or cryptocurrency on this list as they are incredibly volatile, and certainly not recommended for any new investor.
We will provide a brief description of each of these main asset classes below for your further understanding:
Stocks and Shares
A single share can be considered as a tiny slice of a companies value. If you own a share in any company, you are a part owner of that company and are entitled to any increase in value of the share as well as any decrease in the value of the shares.
If the company also pays a dividend after having a good year, then you will be entitled to your proportionate share of the dividends paid.
It is more usual to invest a sum of money such as £1,000 or £10,000 into a company than to consider buying 50 shares 100 shares or 50,000 shares.
Individual stocks and shares are often considered to be at the riskier end of the spectrum, as you are investing in a single company, and that single company could go bust, or it could hit very difficult times, and therefore you will lose a significant amount of money if your chosen stock doesn't perform well. Examples of individual company shares could be BP, Rolls Royce Taylor Wimpey or Tesla.
corporate bonds otherwise referred to just as bonds are simply IOU’s issued from a company to people who have lent them money. In exchange for lending a company a sum of money, otherwise known as the principal, the company will pay you a fixed interest rate usually once or twice a year for the privilege of borrowing your money. At the end of the Time frame agreed, you would get your money back as well as all the interest you have earned over the previous years.
Corporate bonds can pay yields of between 1% up to 7 or 8% depending on the credit risk or quality of the company. In short, larger companies such as Coca Cola will pay a lower rate of interest than smaller more risky companies.
Bonds can also be issued in the name of countries, for example the UK borrows money by issuing bonds called Gilts, and the USA issues treasury's.
It is usually considered that corporate bonds are lower risk and slightly safer than stocks and shares. Although if investing for beginners, you should be aware that bond prices can also fall, and you may lose all your money if the company who has borrowed the money goes bust.
Mutual funds and trusts
Funds and trusts operate in slightly different ways, but the principle of them both is similar. This is to gather a collection of individual stocks and shares into a group chosen by a professional and experienced fund manager, with the aim of beating the overall stock market, whilst also mitigating certain amounts of risk by choosing many different companies instead of just one.
It should be noted that some funds only invest in 40 different companies, whereas other funds can invest in quite literally thousands of different companies, and from numerous different regions around the world.
Funds and trusts are also considered to be less risky than individual stocks and shares, due to the larger number of holdings in each portfolio, but that doesn't exclude them from suffering significant drops in price when the markets do fall.
It is also worth understanding that funds can also be split into two categories, known as active fund management and passive funds. As the name implies, active fund management involves more hands on management from a professional, which incurs an increased fee.
Passive funds simply track a particular index, and do not need day to day management by a highly paid fund manager, so are usually much cheaper to run, and are an investing for beginners favorite.
When we say property here, we are talking about property funds, also known as REITs. These funds invest in either properties directly or companies that own property and rent or lease them out.
The idea of a property fund is to diversify from the standard stock market, and also generate a decent ongoing dividend return from the proceeds of the rental income achieved. These funds typically invest in commercial property like large shopping centres or warehouses.
Commodities can cover a number of assets from gold and silver and platinum, to oil, coffee beans, lean hog, and all sorts of other weird and wonderful items.
As a beginner investor it is worth being aware of these assets, and even have a small exposure to some of them such as the precious metals, but you should be aware that they can be volatile, and the prices can go up and down at a moments notice.
It's also worth noting that precious metals do not provide a dividend or return / yield of money, so you are only investing on the assumption that the price of the asset will increase.
Holding a small amount of commodities can help diversify your portfolio, as they tend to be uncorrelated to the stock market. When investing for beginners, you should probably hold no more than 5% in this total asset class to begin with.
The word diversification in investing is sometimes referred to as the only free lunch in investing.
What this means in summary is that when choosing and investing in a selection of assets, you should spread your risk by buying a selection of different asset types and asset sectors, including regions, thereby mitigating your risk of any one class or region or type of asset collapsing and wiping out all of your investments.
In very simple terms, consider it as not putting all your eggs in one basket.
When constructing your investment portfolio, you should also consider that it is appropriately diversified.
By way of an example of a well-diversified portfolio, you could hold a selection of stocks and shares and corporate bonds and property funds and a small selection of commodities. Furthermore, these asset classes could apply to worldwide regions including the UK, the USA, Asia, Europe and the developing world.
This would then give you the greatest diversification and hopefully spread the risk widely enough to mitigate any severe shocks.
Do be aware that this doesn't totally mitigate the risks as was demonstrated during the COVID pandemic, when pretty much most asset classes tumbled during February and March 2020.
Should I start investing?
Great question, and if you have just read the entirety of this investing for beginners guide, and are still interested and motivated to start investing, then that is great news.
However, we cannot tell you if you should start investing and nor should anybody else, especially the man down the pub. Only you can decide for yourself if investing is right for you, based on many of the questions already raised in this article, and maybe also some investing books.
That said, so long as you have cleared your expensive debt, have some emergency cash spare, and also have some spare cash left over each and every month that you won't miss, then all things being equal, trying your hand at investing could be a sensible and prudent thing to do.
How much money should a beginner invest?
This question is also impossible to answer on a global basis, as each and every potential new beginner investor has different levels of expenses to pay for, and differing amounts of spare cash available at the end of every month.
We would suggest that when beginning your stock investing journey, you drip feed any spare money in on a monthly basis, and also ensure that you are happy or able to tolerate the total loss of these funds.
Once you get used to seeing share prices go up and down on a daily, weekly, monthly, and even annual basis, and you feel more comfortable with the volatility that you are experiencing, then you may want to increase your contributions each month or even consider putting in lump sums as an when spare cash becomes available to you.
Tax free investing?
For those readers based in the UK, we have some fairly generous tax free investment opportunities available to us.
These tax efficient saving schemes should always be the first to be used in order to maximise potential returns.
When investing for beginners, you should always start with a tax-free ISA, as that allows you to invest up to £20,000 each and every tax year, and not be subject to any income tax, capital gains tax, or dividend tax, from any gains that are made.
The other longer term tax free savings vehicle is known as a pension savings scheme or SIPP or self-invested personal pension. SIPPs are incredibly tax efficient as you get tax relief on your initial contributions, and higher rate taxpayers can also claim back additional tax relief on their self assessment tax return each year.
Be warned though, whilst saving for pensions is a very tax efficient method of saving, you are not able to remove any of your savings invested until you are aged currently 55, rising to 57 in the not too distant future.
So those younger investors need to be aware that once the money is invested, it is gone until your desired retirement date, many years or decades down the road.
If you are in your 40s or 50s already, then investing in a pension scheme may be a very sensible thing to do, if you are not already doing so.
Should you invest a lump sum or drip feed your money
Whilst investing an initial lump sum would get your money working immediately, there are risks involved with this strategy. Should the market fall in the next day, week, or month, then you would have an immediate capital loss on your hands.
Therefore, it is usual for beginner investors to drip feed money in on a month by month basis, thereby benefiting from what is known as pound cost averaging.
Pound cost averaging simply means you smooth the average price you buy your assets at over a period of time. When the asset prices are high you buy fewer units, and when the asset prices are lower, you buy more units, and ultimately you get a blended price overall.
Drip feeding is more a hedge against markets suddenly falling, because if you didn't invest your lump sum at the beginning of the year, and the markets rocketed up for the next two or three years, you will have been worse off by drip feeding and pound cost averaging overall. But when investing for beginners, drip feeding is the best option to begin with.
5 Investing for Beginners Golden Rules
The higher the reward you seek, the greater the risk you will have to take.
Don't put all your investment eggs in one basket. Diversify!
Investing is for the long term, preferably five years minimum.
Review and re balance your portfolio at least once a year.
Stay calm, markets go up and down all the time, volatility is usual.
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