Investing can be one of the best ways to grow your money and help to ensure your long-term financial wellbeing.
In this blog, we’re going to cover some of the key topics about investing for beginners, including:
- 🤷♂️ Why you should consider investing
- 🔑 Two key types of investments
- 📊 The difference between investing and trading
- ⚖ The importance of diversification
- 🙅♀️ Common investing mistakes to avoid
- 📚 What to read to learn more about investing
What is an investment?
An investment is an asset that you buy with the intention of selling it for a higher price in the future, or that you hope will directly generate income.
Why should you invest?
Here are three reasons you should consider investing:
- It can offer greater returns over the long term than savings: the average annual return of the FTSE 100 (an index of the 100 largest companies on the London Stock Exchange) over the last 25 years was 6.4%. This means that if your savings account gives you 0.1% interest, the stock market is giving returns of 60x more
- It offers greater protection against inflation: inflation means each unit of money you own is becoming less valuable. Investing gives you a chance to earn higher returns than the rate of inflation, meaning your total amount of money will increase in value
- It’s more tax-efficient: tax on dividends is between 7.5%-38.1%, whereas the tax on income = 20-45%
Two key types of investment
A share is a chunk of the ownership of a company. When you buy a share, you become a shareholder and you’re then participating directly in the fortunes of that company: if the company does well, your shares are likely to increase in value, but if it does badly your shares will lose value.
(You’ll see the terms ‘share’ and ‘stock’ both used: they mean the same thing and can be used interchangeably.)
There’s short term risk involved with investing in shares – any event, such as the Coronavirus pandemic, could come out of nowhere and cause a huge drop in the value of your shares at any point in time. But there’s also long-term risk – if the company that you invest in fails, you could lose all the money you invested forever.
In a fund, many different people’s money is pooled together to buy a range of different assets that are held together. You then own a chunk of that pool equivalent to the proportion of the money you contributed.
Funds are seen as less risky than shares because they hold a range of different assets, rather than just shares of a single company – they’re more diversified (we’ll explain this in detail later).
Types of fund
Managed fund: these funds are also called mutual funds. Money is contributed by different investors and is managed by an individual investor (called a fund manager) or a group of investors. A fund manager can be active (meaning they regularly change the assets in the fund to try to get the best return) or passive (they change the assets infrequently e.g. once a year) – actively managed funds usually have higher fees.
Index fund: track the performance of a particular set of assets. Common index funds track the performance of stock exchanges, such as the FTSE 100 index.
Index fund exchange-traded fund (ETF): investing in an underlying benchmark index but unlike other funds, which usually can only be traded at one time a day, these are traded like shares so can be traded whenever the stock market is open.
There’s a large range of funds and shares in terms of their risk, but no matter how low the apparent risk is, there’s always a chance that you might lose all of your money.
What is the difference between investing and trading?
It’s important to distinguish between investing and trading because they represent two very different behaviours.
Investing is about buying assets that will bring you long-term gains. There’s no intention of making money in the short term. The time horizon for an investment can be anywhere from 1 year or longer.
On the flip side, trading is all about buying and selling assets for short-term profit. Whereas investing focuses on the value of the investment, trading solely focuses on prices and trying to take advantage of fluctuations in price.
Traders buy and sell assets weekly, daily or even hourly to try to make a profit. Trading is much riskier than investing as there is no diversification (traders are usually trading individual stocks) and some of the trading techniques they use can lead to big losses if the market doesn’t move in the direction they hope it will (they often try to make money on prices rising and falling at different times).
Risk and diversification
Diversification is the idea of buying different assets so that your overall portfolio (your collection of investments) balances out better and is less risky.
There are lots of ways of diversifying:
- By region e.g. Europe, America, developed world, developing regions
- By sector e.g. tech, finance
- By theme e.g. defensive (assets that grow regardless of what’s happening e.g. food), cyclical (go up when the market is good, go down when the market is bad)
- By class e.g. shares, bonds
- By risk profile e.g. more risky vs. safer investments
Imagine you own 1 share of an ice-cream company, which makes up 10% of the company:
You can see that, if the weather is good, your investment can be really profitable. But if the weather is bad, you’re at risk of losing money.
When you diversify, you buy into different types of companies so that, no matter what’s happening, one of the companies you invest in should be performing well.
Instead of buying just one share in the ice-cream company, you could also buy one share in an umbrella company and one in a hamburger company. Or you could buy one share of the weather fund, a mix of the shares from the three different companies:
By investing in the weather fund, although returns will be a little bit less on average than if you just bought the most successful stock, no matter what is happening, the fund should increase in value over time (as long as the companies are successful).
Diversification is important because there’s no such thing as a 100% guarantee. Even if you invest in Amazon, which is much less likely to fail than other companies, there’s a possibility that the business could fail and you could lose all your money. It’s much better to have more modest returns than to chase the quick, big win and potentially end up with nothing.
How do I start investing?
It’s best to make sure that any money you’re investing is not money you’re relying on to pay your bills or that you can’t afford to lose – as we’ve said, there’s no guarantee that any investment you make will be successful. Also, remember that investing is about making long-term gains, so it’s best not to invest any money that you can’t afford to wait at least a year for.
Now you’ve decided you’re ready to invest:
- Educate yourself: the differences between different types of investment, what you want, what your ambitions are, what your time horizon is
- Do a “dummy run”: pick a couple of stocks/funds and watch them. Just keep an eye on what they do on a regular basis so you can see how you react
- Open an investing account and invest a small amount: so you can try the market out, get a feeling for it and see how your money going up and down makes you feel. £50/£100 could be a good place to start – this is unlikely to be catastrophic to your budget but is enough to test the waters
- If you’ve confirmed with yourself that you’re comfortable, start investing regularly
Avoid these common investing mistakes
- Make decisions based on tips or ‘sure things’
- Be aggressive when you can’t afford to be
- Be emotional when investing
- Wait to get your money back when you’ve made a bad trade – sometimes the best thing to do is accept a loss and move on
- Invest more than you can afford to lose
- Take any kind of leveraged position – this is when you borrow money to invest it. Some companies allow non-professional investors to do this, which is very dangerous. It means you can lose a lot more than you invested in the first place
- Try to time the market
- Trade in illiquid stocks – stocks that other people don’t want to buy. If there are only 5 buyers for the stock when you want to sell, you’re going to have a hard time getting your money back out
- Believe cheap to mean valuable
- Believe all stocks bounce back – they don’t!
What to read to learn about investing
- ‘The Intelligent Investor’ by Benjamin Graham
- ‘The Little Book of Common Sense Investing’ by John Bogle
- ‘Thinking, Fast and Slow’ by Daniel Kahneman
- ‘The Essays of Warren Buffett’ by Lawrence Cunningham
- ‘The Total Money Makeover’ by Dave Ramsay
- ‘The Richest Man in Babylon’ by George Clayson
- ‘Think and Grow Rich’ by Napoleon Hill
Final tips and hacks
Here’s are some final tips & hacks:
- Pay yourself first: if you decide to spend your money first and save/invest whatever is left over – you’re probably not going to have very much (if anything) left! Instead, set aside money to save/invest before doing any spending – that way, you can guarantee you’ll stick to your goals
- Automate your savings/investments: if you have to remember every month to set aside money, it’s likely you’ll forget and not stick to it. Set up a standing order/automatic transfer for the same day each month to make sure it happens and take the pressure off your brain to remember
- Make the most of cashback opportunities: as long as you were going to buy that thing anyway
- Unless you can buy something twice, you probably can’t afford it
You can learn more by watching the recording of our webinar, ‘How to Grow your money through investing‘:
On the Blackbullion platform, we cover 80+ financial topics to help you to learn to manage your finances better and improve your financial wellbeing. Start learning now.
Blackbullion is an education company and is not authorised or regulated to give advice. All information presented should be considered educational and not guidance and Blackbullion takes no responsibility, and can not be held responsible, for decisions made, or the consequences of those decisions. You should seek professional financial advice.