Your First Steps in Investing
At some point in your investment journey you will make your first investment. It can be a scary leap to take your hard earned cash and put it into something with unpredictable returns. The world of investing can also seem like it's only for experts but it's actually surprisingly accessible and easy to do for anyone, so long as you understand a few basics.
If you're thinking about getting started with investing or are close to making your first investment then this article will walk you through everything you need to know to get started.
What is investing?
Investing isn't scary, or something that only people with lots of money and experience and risk tolerance can do. It's not about taking risks and making millions (or more likely going broke) but rather it's about doing something more productive with your money than having it sit in a cash savings accounts.
An investment is just something you own which you expect to either go up in value or produce income for you. Owning shares in a company is one example, since companies tend to both grow and pay out portions of their profit as dividends to their shareholders. Other examples of things you could own as investments are government bonds, corporate bonds and precious metals.
What should I invest in?
Sadly, there is no definitive answer to what you should invest in, but there are a few well understood principles that should let you construct an investment portfolio that is right for you:
There is always uncertainty in investments but you can reduce the risk and volatility by being invested in lots of different things. For example, if you only held shares in only one company, and that company went bust, you would have lost all of your investment. However, if you were invested in 100 companies, then chances of them all going bust is much smaller small, and so your risk is significantly reduced.
If all of those companies were in the same sector, or of a similar size, then there are still risks of the economy shifting in a way that puts all of those companies at risk at the same time. To help prevent this, you could diversify your investments across companies of different sizes, and in different sectors. You could also invest in other types of investment, like bonds. Ideally, you'd hold investments where the behaviour of one investment is unrelated to the behaviour of the others.
Be in the market, don't try to beat the market
If you look at the historical trend of the UK and world stock markets, there has been long term growth. This may not be true year to year but on a long enough time-frame it is. If you had a small investment in every company in the UK, you would have historically seen long-term growth of your investments, regardless of the individual success or failure of each company.
An alternative strategy would be to try to pick individual companies and investments which you think will do well. However, it's nearly impossible for an average investor to reliably pick investments that will beat the market on average. There are lots of well-funded, clever people working on this full time who struggle to do so, so you probably can't. Instead, if you can aim to replicate the growth rate of the market through your investments, then you will historically achieve reliable long-term growth, which is a good aim to have.
How to achieve these aims
To be diversified and replicating the market, you'd need to hold many hundreds or thousands of investments. Fortunately, there are things called funds which handle all of this for you. You buy units of a single fund, which in turn holds many hundreds or thousands of shares in different companies, or bonds, across different countries, or sectors, or sizes, depending on the fund.
The Vanguard Lifestrategy funds are specifically designed to meet the above aims. These funds are popular amongst individual investors who want to have a passive approach, holding investments in a small number of funds which are a diversified across different sectors, assets and markets.
See the article on index funds for more information.
The logistics of investing
Buying units of these funds is a little more complicated than adding cash to a savings account, but not much more. You will first need a trading account with a broker. This is like a bank account, but where you can hold investments in shares, bonds, funds and other tradeable assets. Like a bank holds cash on your behalf, a broker holds the investments on your behalf, and interacts with the systems and markets where these investments are bought and sold.
Monevator maintain a list of brokers, and the fees they charge, which may help you in selecting a broker to use. Opening an account tends to be similar to opening a bank account in terms of the number of hoops you need to jump through, but different brokers may have different processes.
After you've opened a trading account, you can transfer cash into the account. From there you can use that cash to buy units in a fund, or other investments. The price of a single unit of a fund varies daily based on the value of the underlying assets. When you choose to buy the fund, you will typically tell your broker to buy some amount, for example £1,000, of the fund. The broker will then execute this trade for you. For some asset types, like shares in a company, this may happen quickly, but for funds like the Vanguard Lifestrategy, these trades happen once per day. So you will find out the next day (or potentially a few days later), what the price was at the time of your broker performing the trade for you, and so how many units you have actually ended up with. Note that unlike shares in a company, you can hold fractional units of a fund, so you can likely choose down to the penny how much to invest, regardless of the price of the fund.
Different types of account
You may have some of your cash savings in an ISA, where any interest is tax free and that you can contribute up to £20,000 per year to. You can also hold your investments in a similar Stocks & Shares ISA, where any income and or capital gains from your investments are tax free. You have a total allowance of £20,000 per year across both cash and Stocks & Shares ISAs.
You can also hold your investments in a SIPP (Self Invested Personal Pension) account, where any contributions get a tax rebate, but you can't withdraw until you are 55.
When you open an account with a broker, you will have the choice of opening a regular trading account, an ISA or a SIPP. You will be able to open multiple accounts of different types if you want to.
Before you make your first investment, it's important to know that holding investments may introduce some additional complexity to your tax situation:
- If your investments produce income from interest payments or dividends, you are liable to pay income tax on these. This tax will not be deducted automatically as it is when you are a PAYE employee, and so will need to report this to HMRC yourself via a self assessment tax return.
- When you sell any investments, you may be liable for capital gains tax. If you bought some assets for £10,000 and then sold them for £12,000, you would have made a capital gain of £2,000, on which capital gains tax may be due (although you have a tax-free allowance each year).
The above only applies to investments outside of a tax-efficient wrapper. Investments in an ISA or SIPP will not be liable for the above taxes.
This article is intended to be a broad overview of what you need to know and think about while investing, but it's certainly not comprehensive. You should make sure that you fully understand the implications of starting investing, do your own research, and speak to a financial advisor if you are uncertain. Good luck on your investment journey!
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