Hello everyone – today will start a series of posts for those who are thinking they want to invest or are thinking about it for the future, but aren’t quite sure of what their potential options might be.
Obviously the Wilderness is a big fan of investment and believes that it pays off longer term – you can read a more detailed post on exactly why that’s the case here.
Obviously, the usual disclaimers apply that you should always do your own research on investments and the below is not financial advice. The descriptions here are designed to be simple and explain the broad context of each option rather than being a complete assessment of it.
So let’s get started – how exactly should we slice up that investment money?
Well you should be pretty familiar with this one so I won’t say too much about it! You’ll earn a little interest from a bank account at practically no risk, with your savings up to £75,000 protected by the Financial Services Compensation Scheme.
At the present rate of interest (the centrally set lending rate that will determine what extra your current account pays you) you’re actually likely losing money in reality, as inflation (the rate prices go up) will outstrip that. However, it’s convenient and we always need some cash in hand.
Banks don’t literally put your money in “the bank” – they’re wanting it so the money you’ve given them as a saver they can lend out to others and get a return on it. It’s therefore helpful to them to know that you intend to leave your money with them for a set period.
A term account therefore pays a higher rate of interest in exchange for you locking your money up for a set period – it’s a little bit more for you for a little bit of inconvenience. Term accounts can be a helpful tool as if you hit a point of dire need, you can usually (check the terms of any you enter into) withdraw your money and simply forego the interest you would have earned.
Now we’re getting into the more serious end.
A bond is where you buy the debt of a company or institution – essentially it’s you lending someone some money and getting an “IOU” for the same amount plus a little more back.
I’m grossly oversimplifying here but the primary risk to you is usually credit risk (the risk that the person will not pay you back). Lending to the UK Government is pretty safe – you know what they’re about and you know you’re likely to get your money back. Lending to DodgyCo of DodgyCountry – well you’ll need a serious incentive to give to them as you might not be seeing your money returned to you.
The amount a bond pays out should therefore relate to the level of risk involved – if a bond is paying you a really high rate, you should ask yourself why.
In terms of timeframe you’ll commit to a period of lending the money, usually between 3 months to 5 years, and expect higher returns for locking your money away for longer periods. This obviously may mean you cannot use it for other opportunities.
In terms of payouts, bonds may either repay the initial amount (which may be referred to as the principal) plus your interest at the end of the period or pay you occasional smaller amounts during the period of the investment (known as coupons) before returning your original investment at the end.
If you’re a novice investor, you are likely to be able to find simple fixed-rate bonds issued via your bank/building society, or to invest in via an index fund (more on that below).
Investing in an individual company’s bond in the wider market is a more risky proposition and should be treated with great care by the inexperienced investor and preferably under advice. Higher end names can be a good investment, but those with low-quality credit profiles (known as junk) have a high probability of loss via the underlying company going bust and not paying out.
So in the case of bonds you’re buying the debts of a company. In the case of equity (also known as stocks or shares) you’re buying a piece of that company, essentially a small ownership stake. The value of it will therefore change alongside the value of the company.
Equities in general are this far down the risk-list because they are much more volatile than bonds, with larger swings in markets seen over time even in names of well-known companies. We can illustrate this with this graph of the FTSE 100 which shows the market high and low in each year since 2000.
There’s a few ways we can invest in equities, but any investment in this field should ideally be for the longer term.
A few of those choices are:
Investing in a fund: A great choice owing to their ease. With equities you want to diversify (I.E hold a range of different stocks with different characteristics) as it’ll smooth out your gains and losses into a more consistent return over time. By buying into a fund, you essentially purchase a pre-made pool of stocks and so get the benefits of this already done.
There’s a few different options when it comes to funds. You can either choose a passive or active form of management.
An active fund is run by an individual or team of individual professionals who pick stocks based on their market experience, and research how they might be able to beat the market based on their knowledge of the companies they invent in.
An index fund is designed to simply hold a variety of stocks under a pre-defined criteria. and sticks to it. For instance a type of index fund known as a tracker might simply hold all stocks in the FTSE 100 index and try and replicate it’s performance. Others might offer stocks only in the major currency. With the criteria in place, the need for investment decisions is very limited and often automated.
So which is better, index or active? Well that’s something of a controversial topic in financial markets! Naturally we’re drawn to active funds, as the idea of someone making conscious choices based presumably on logic sounds much more intuitive than a pre-set criteria.
The body of evidence however generally suggest index funds appear do better though. (This is largely because the costs of running an active fund are generally higher, so after adjusting for costs and fees the gain can be bigger).
Whilst you can buy and sell a position in a fund, you really should look at this ideally as a much longer term investment. You should also be aware that some funds have restrictions on how quickly you can withdraw funds and should check this.
Private Wealth Management: With this option you basically hire a professional to research and manage a stock portfolio specific to your needs.
There are advantages to this – a good wealth manager will take into account your specific circumstances directly and help you plan for life events, and take into account any investment priorities you have. They’ll also thing about how to optimise your investment by taking into account matters like tax planning.
As you can imagine, this one is at the top of the tree in costs – but can be worth it if you get a really good manager who can justify the rate of return. Unfortunately a good few can’t and a scary number don’t even beat the market before costs, so you need to pick a manager with great care……
Investing directly in an equity: You can of course buy shares in a single company through a brokerage service. For a novice investor, the funds route is a lot safer – if you are going down this route you need to think about diversification, as you can end very exposed to market movements – not something to do lightly with your life savings.
Alternatives, like wine/whiskey/bitcoin etc:
Just do yourself a favour and steer clear! From the beginning of time people have wanted to invest in something they feel they like or even have a reasonably good knowledge of. To be able to make money (consistently) in these fields is something that’s specialized and you need to have a fundamentally detailed understanding of to make anything other than unreliable short term gains. It’s ended in tears for many – don’t be tempted. Just enjoy drinking your wine instead!
What would I suggest? For a novice investor, a combination of basics in a current account and a well-researched index fund can do a lot between them and is easy to keep on top of.
With any investment you obviously need to think about your personal circumstances as well – the next post in this series will deal with some ideas of how to understand what level of risk you’re willing to take.
The next post in this series is now available! You can read about understanding your investment risk profile here.
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