Investments (2024)

Forbes Staff

Saving typically refers to putting money to one side, usually in a cash-based savings account. Here you will be paid a rate of interest and your money, or ‘capital’, will not be at risk.

If a UK-registered savings account provider goes bust, account-holders are protected to the tune of £85,000 by the government-backedFinancial Services Compensation Scheme.

Over time, however, the purchasing power of money on deposit will be eroded by inflation. More on this below.

When you invest, you put your money into a range of different assets, from property to shares.

This differs from saving due to the uncertainty over the amount of money you will receive when you sell the asset. The value of the asset might rise, but you also risk making a loss if you have to sell the asset for a lower price than you paid.

So why do people choose to invest rather than save their money?

• Potential for higher returns:investors have the potential to earn higher returns on investments than savers with deposit accounts. According to AJ Bell, the averagecash ISAhas delivered a total return of 17% over the last decade, compared to 100% for the averagestocks and shares ISA. A lump sum of £10,000 invested in a fund-based ISA would have grown to £20,000 over a 10-year period, compared to £11,658 in a cash ISA.

• Protect against inflation:inflation is currently near a 40-year high of 9.9% in the UK, while the average interest rate on instant access savings accounts was 0.47% (at September 2022), according to the Bank of England. If you invest money in a savings account paying 1%, and the inflation rate is 9%, the ‘real’ value of your money is effectively reducing by over 7% every year. Investments have the potential to make higher returns to help counter inflation.

• Compound growth:compound growth occurs when any income or interest is reinvested and grows along with the original money or ‘capital’. If you invested £10,000 for 10 years with an average annual return of 5%, it would be worth £15,000 if you withdrew the ‘gain’ each year, compared to nearly £16,300 if you reinvested it. As investments generally offer higher returns than cash, compound growth makes investments grow in value even faster.

1.Do you have an emergency savings buffer?

The rule-of-thumb is to build an emergency fund to cover three or preferably six months of living expenses. This could cover unexpected costs such as car repairs or bridge a gap between jobs. It’s recommended this money is held in aninstant access savings accountso you can withdraw it at short notice without penalty.

2.Do you have any high-interest debts?

If you have personal loans or credit card debt, it makes sense to repay these first if you’re being charged high interest rates. It may also be worth looking at cheaper options, such as a0% balance transfer credit cardor a lower interestpersonal loan.

The rough rule is that, if you’re paying more in debt interest than your money is earning, you should use the money to pay down or clear the debt.

3.Do you understand the risks?

Although the risk varies by the type of investment, investing carries the risk of losing some, or all, of the money you invest. There is also a risk that returns might be lower than expected. You should not invest money if you are not comfortable in taking these risks.

Before deciding on the type of investments to make, you should think through the following questions to help you make the right investment plan for your circ*mstances:

1.What are your financial goals?

Start off by establishing your overall financial goals. Short-term goals might include buying a car or putting money aside for a deposit for a house in the next two or three years.

You might have medium-term goals, such as building up a fund to support your children, or going on a once-in-a-lifetime holiday.

Long-term goals might be to start investing in a personal pension to supplement your state pension.

It’s important to set your financial goals at the outset so that you can match the most suitable investments in terms of time periods, together with their associated risk and returns.

2.How much can you afford to invest?

Having put aside money for a rainy day fund, the next decision is how much to invest.

It’s a good idea to work out whether you have money left over at the end of the month after paying your expenses. If so, you might want to consider investing a regular amount every month to build up your investment pot over time. Or you might look at investing a lump-sum such as a bonus or inheritance.

Whichever option you choose, you should work out the amount of money that you are able to invest and whether you might need to access this money in an emergency.

3.How much risk are you willing to take?

On the whole, there is a correlation between risk and return – investors who are willing to take on a higher level of risk are potentially rewarded with a higher level of return.

Government bonds or ‘gilts’ are considered low-risk investments and currently offer a return or ‘yield’ of 1-2% (based on their current trading price).

Investing in the stock market is higher risk but the FTSE All Share index has produced an average annual return of 10% over the last 30 years, according to Vanguard Asset Management.

Within the stock market itself, there’s a wide variation in risk and returns. For example, among the 57 investment sectors, Latin America has delivered one of the highest returns of 5% to date in 2022 – but after posting the lowest returns across the sectors in the previous two years, with negative returns of 12% and 15% in 2021 and 2020 respectively, based on data from Trustnet.

4.What is your time-frame?

Having decided on your financial goals, you should work out how long you want to invest your money for. In general, you should look to invest for at least five years – stock markets can fall, as well as rise, and this helps you to smooth out the average returns.

Investing for less than five years can present challenges. If you need to access your money at short notice, and your investments have temporarily fallen in value, you may be selling them at a bad time.

If you may need to access your money in the next few years, you’d be better advised to keep your money in savings accounts where your capital is protected.

By the same token, if you are looking to invest for a longer period of time, such as for a pension, you may choose higher-risk options as your investments have time to recover from any dip in value.

Whatever your chosen time period, it’s wise to change the balance of your portfolio as you approach the time to sell the investment. Selling a proportion of your stock market investments over time, and depositing the proceeds into a savings account, protects your money against a short-term fall in the stock market.

5.Are you looking for income or capital growth?

There are two types of return on investment – ‘capital’ growth (an increase in the value of your investment), and income.

With a savings account, you receive an income in the form of interest. With investments, it usually takes the form of dividends – these are cash payments made by a company to shareholders, usually on a yearly or half-yearly basis.

Although many people invest in the stock market for capital growth, the ability to produce an income stream can be useful. For pension investments, an income stream can be used in retirement, while leaving the capital invested to grow in value and produce income in the future.

However, there can be a trade-off between income and capital growth. Some of the high-growth, US technology companies choose to reinvest surplus profits rather than pay a dividend, which should theoretically lead to higher capital growth. In contrast, some lower-growth,blue-chip companiesin the UK pay regular dividends to shareholders.

You can usually buy ‘income’ or ‘accumulation’ units if you’re buying a fund-based investment. With ‘income’ units, any dividends or income are paid out in cash to investors, whereas this income is reinvested to buy additional units under the ‘accumulation’ option.

There’s a wide choice of assets to invest in – from physical assets such as property, classic cars, fine wine and jewellery to financial assets such as shares, funds and bonds.

If you’re looking to invest in financial assets, it’s important to spread your investment across different asset types. A balanced and diversified portfolio helps to protect against one investment underperforming and may also smooth out the different levels of volatility.

Let’s take a closer look some of the options available to investors:

1.Shares

Buying sharesin a company may reward investors with capital growth and an income in the form of dividends. There’s a wide choice, including 1,300 companies listed on the London Stock Exchange.

Half FTSE 100 companies delivered a double-digit gain in share price in 2021, according to research by interactive investor. Top of the pack was plant hire provider Ashtead Group, achieving a 72% increase in its share price over the year.

At the other end of the scale, Flutter Entertainment, a sports-betting company, suffered a 27% decrease in share price in 2021.

However, investing in shares is a higher-risk option as the share price is impacted not only by the stock market as a whole, but also by company-specific factors.

One option is to invest across a number of companies in different sectors, alternatively, investing in a fund offers a ready-made portfolio of shares in companies.

2.Investing in passive funds

A passively-managed fund, also known as a ‘tracker’ or ‘index’ fund, aims to replicate the performance of an index such as the FTSE 100 or the Nasdaq. The fund will buy all of the underlying shares in the index, usually in the same proportion as their market value.

Passive funds are also a low-cost option – Morningstar reports that average annual fees are 0.12% for passive funds, compared to 0.62% for actively-managed funds.

Passively-managed funds come in different forms but exchange-traded funds (ETFs) are one of the most common types.

In addition to the main stock market indices, some of the more specialist ETFs also trackcommodity indicessuch as precious metals, crude oil and semiconductors. WisdomTree Tin was one of the top-performing ETFs in 2021, delivering a return of 135% as tin prices hit an all-time high.

Passive funds are a good option when stock markets are rising as they provide investors with the average return for the index without the risk of investing in an individual company. However, they are a higher-risk option in falling or volatile markets, as fund managers can’t take steps to protect against losses.

3.Investing in active funds and trusts

Actively-managed ‘collective’ investments pool together money from investors to be invested by a fund manager on their behalf. They charge a higher fee as the fund manager aims to outperform an index such as the FTSE 100.

Depending on their investment mandate, they can invest in a range of different assets (e.g. shares, commodities and property), sectors (such as technology, healthcare and infrastructure) and geographies (including the UK, the US and emerging markets).

There are two main types of actively-managed collective investments:

• Funds:these are either unit trusts or open-ended investment companies (OEICs), but the difference isn’t important and they’re both usually referred to as ‘funds’. As an investor, you buy units in these funds, the price of which fluctuates according to the performance of the underlying investments.

• Investment trusts:these are listed on the stock exchange, meaning you buy and sell their shares. Unlike funds, investment trusts are allowed to hold back 15% of income in a year in a ‘rainy day’ reserve. This allows them to maintain dividend payments in more challenging years. Some investment trusts have increased their dividend payments for more than 50 consecutive years.

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