How To Start Investing

Before You Start Investing…

Before you start investing, there are three things you need to do:

• Clear any bad debt - bad debt is things like loans and especially credit cards. This doesn't include a mortgage.
• Develop a regular saving habit
• Build up a 'rainy day fund' of three to six months living expenses

You may also want to keep a budget of your spending to help you reduce and avoid debt, increase savings and know how much you need in your rainy day fund.

Once You Have Done That, You Are Ready To Start Investing.

First Things First:

• Check your risk profile
• Plan for when you might need access to your money
• Use your tax allowances to the full

Design A Balanced Portfolio

A balanced portfolio is a mix of stocks and bonds. The stocks take advantage of long term stock market growth while the bonds provide a cushion to weather the temporary declines.

Deciding what proportion of your investments to put into stocks or bonds depends on your circumstances.

For example, if you are retired and depend on the investments for income, you will need more (but not exclusively) bonds.

If you are in full time employment with some years until retirement, but not enough to retire, you will want far more stocks and shares.

An independent financial advisor can help you decide on the right balance for your needs.

Develop An Investor’s Mindset

Successful investors don’t get sucked into the latest “hot picks” or crypto fads.

They invest for the long term, ride out the inevitable short term declines (no matter how painful) and reap superior returns in the long term.

Take this example five year period for the top 250 companies in the UK. If you invest and then cash out at the points marked by red arrows, because the temporary declines scare you, you will lose money. But at the same time, the investor who stays the course marked by the blue arrow enjoys significant long term financial gains:

Mistakes To Avoid

When designing an investment portfolio there are many pitfalls to avoid. These include:

1. Investing in shares when you should invest in funds to reduce your risk - only consider direct shares if you have more than £250,000 to invest
2. Don’t invest in a share or a fund because of the “Star” manager or CEO. There are more examples of investor losing money when a star manager fails after a good run, than of enduring star success
3. Avoid overlap - check the underlying investments of a fund and don’t buy multiple funds that invest in substantially the same companies.
4. Diversify globally. Diversification is important to reduce risk. But if you overdiversify you kill investment growth. So diversify to reflect the market capitalisations in the main Global markets.
5. Ensure liquidity in case you need to withdraw your investment because of a change in your circumstances. A fund might be an exchange traded fund, unit trust, open ended investment corporation or investment trust. They all have slightly different structures and terms. Understand these and who really operates the fund before investing.
6. Don’t invest all your money in one globally diversified fund - no one can be all things to all people and fund managers are no different. Build a portfolio of a few specialist funds that can be measured against specific targets.

An Example Portfolio

The Personal Investment Management & Financial Advice Association (PIMFA) indices are established benchmarks for designing investment portfolios.

Two of their indices are shown below and recommend how to divide up your investments to achieve ‘growth’ with the associated risk or a safer ‘conservative’ approach for a more cautious investor:

Figure 1: PIMFA Investment Indices

(MSCI PIMFA Private Investor Growth Index, and MSCI PIMFA Private Investor Conservative Index)

Here is some detail on each of the above investment types:

• Equities or shares in companies and funds, provide the opportunity for growth but are infamously volatile. They are included to produce growth, and their risk is offset by other investments.
• Government bonds (known as Gilts) are issued by the Government’s Debt Management Office and provided an investor buys at par value and holds them until redemption they are guaranteed the fixed interest returns. The minimum term however is 5 years and shares historically outperform them.
• Corporate bonds are issued by large corporations, usually with good credit ratings, to finance long-term projects. Again the minimum term is usually 5 years. Corporate bonds are very similar to gilts, in that they pay a fixed rate of interest and have a redemption value, but yields tend to be higher. However because they are backed by corporations not governments, they are more volatile and there is a risk that the company may not be able to repay at the end of the term.
• Inflation linked bonds are bonds that are linked to an index, usually the Retail Price Index, which means your bond’s redemption value will rise each year with the RPI, so that money will be protected from inflation.
• Cash, keeping a small amount of your portfolio in cash provides some liquidity for paying fees or emergency withdrawals. The contribution to the portfolio’s performance is estimated based on the Bank of England Base rate.
• Commercial property is a relatively stable market compared to equities and residential property. Investment in a commercial property fund can therefore help to balance the wider investment portfolio, providing stability.
• Alternative investments are not regulated. They can include such things as gold, and even art, antiques or classic cars. Gold can provide some stability when stock markets drop, which is why the percentage allocation is higher in the conservative fund split. You can invest in Gold directly or if you don’t want to deal with storing actual gold, you can invest via ‘Exchange Traded Commodities.’ While art or classic cars can provide short term periods of high growth, they are to be used as a small part of the portfolio mix because of their very risky nature.