Reasons for investing
Once you’re sure that you’re comfortable with the risk that you could lose money, and are happy that you won’t need to access your money for at least five years, the next step is to think about your current financial situation and your reasons for investing. For example, you might be:
- Seeking potentially higher returns on your savings to pay for that far-off retirement holiday
- Saving for your children or grandchildren’s education or wedding
- Planning for your retirement.
Your reasons for investing will help you work out your investment goals and influence the way you manage your investments.
What are your investment goals?
When it comes to setting your investment goals or strategy, there are two main options:
- If you’re looking to build up the value of your investments over time, you’re investing for growth
- If you’re aiming to get a regular income from your investments, then you’re investing for income.
Investing for growth
Investing for growth means using your money to invest in products that are likely to have the potential to increase in value over time. Let’s say you have £1,000 to invest. If you invest for growth, your goal may be to turn that £1,000 into £1,200. So you’re not looking to make a regular income from your investment, but are hoping for a long-term gain. Though of course, you also risk losing your money.
Growth investing with funds
If you’re just starting out, funds can be an easy route in to growth investing. The aim is to grow your money by investing in funds whose units or shares aim to increase in value over time, so long as market conditions are favourable.
Funds invest your money in a wide range of assets e.g. shares or bonds. A fund manager selects these assets based on the fund’s objective, so you benefit from their experience.
There are thousands of funds available, each with its own objective – e.g. ‘invests in large UK companies’ or ‘invests in US companies’.
With some funds, your money is invested in a wide range of assets without you needing to buy each of the underlying components. In this way, funds provide diversification to an investment portfolio, which can help spread risk in a way that buying shares in just one company can’t.
Like most investments, funds are designed to be held for at least five years. This is because in a typical economic cycle, it is hoped that five years may be enough time to recover from downturns in the market. Of course, this isn’t a guarantee – you can still get back less than you initially invested after this time.
Growth investing with stocks and shares
Another way to invest for growth is through buying company stocks and shares, also known as equities. The aim is to grow your money by investing in profitable companies whose shares rise in value. They are also likely to pay dividends to shareholders. You can choose to reinvest the dividends – i.e. buy more shares – or keep the payments as income.
Investing directly in individual stocks and shares is very risky. If the company’s share price drops, you could lose some or even all of your money. That’s why it’s generally considered best to diversify your portfolio by investing in a mix of assets. You can do this through buying shares in a number of different companies, and by investing inother types of assets, such as gilts and bonds.
As we mentioned above, if you’re new to investing, buying funds is one of the easiest ways to achieve diversification. That’s because funds allow you to hold shares in a large number of companies through a single investment. You also benefit from professional managers choosing the individual companies. For these reasons, most people who invest in shares do so through funds.
Investing for income
As the name suggests, when you invest for income, you’re aiming to make a regular income from your investment. You could put your money into a cash savings account that pays regular interest, instead of an investment. As savings are less risky than investments, it’s a popular choice with those who are uncomfortable with the risk that they could lose money. Although, as interest rates in recent years have been lower than inflation, there is a risk of the real value of cash holdings eroding over time.
Fixed-income investments like gilts and bonds are popular investments. These are issued by the UK Government and by companies who then make regular interest payments which can provide a steady income. If you invest in them when they are first issued, your capital will also be repaid at a set date in the future, known as the redemption date. There is always a risk that that those who issue these investments may not be able to make payments due under them, or to repay the capital on maturity. If this happens, you might not get some or all of your money back.
You can buy gilts and bonds from an individual issuer, e.g. from just one company. But if you do this, your risk will be greater as your investment will be tied to that one company’s performance.
Gilts issued by the UK Government provide you with a safer investment because it’s considered unlikely that the Government will default on a debt. However these are fixed-term investments and if you sell before the term ends, you may get back less than you invested.
Spreading your money and your risk
You can also invest in gilts and bonds through funds. This spreads your money across a mix of assets, so your risk is spread too. These types of funds are popular with new investors and those who hold individual shares in their portfolio, as they help bring balance to the portfolio.
Compared with some other investments, funds holding gilts and bonds have historically been considered to be relatively stable. As a result, and because their value rises as interest rates fall, they were very popular in the wake of the economic crisis when share prices fell significantly. Of course, when interest rates rise, the value of these investments would be expected to fall and you should take this into account when choosing to invest in these.
Thinking about timescales;
If you’re investing with a goal in mind, you’ve probably got a date in mind too. If you have a few goals – e.g. investing for your child’s education and your retirement – you’ll be working towards a number of dates. So you’ll probably have different strategies for the different investments you hold.
Investments generally rise and fall in value. So it’s sensible to use cash savings for any short-term goals and only to commit to investing for at least five years. That’s because in a typical economic cycle, it is hoped that this may be enough time to recover from downturns in the market. This isn’t a guarantee – you can still get back less than you invest after this time.
That doesn’t mean that cash is risk-free – it’s not. Since 2008, record-low interest rates and inflation at rates higher than these have reduced the real value of cash savings. So while you always get your money back, you might not be able to buy as much with it.
How timescales can influence your investment choices
These examples show why it’s important to think about timescales:
You’re in your 30s and planning to retire at 60
You’re investing for your retirement. Because it’s a long way off, you might choose investments that are likely to provide growth over the long term (although there are no guarantees, and money could be lost). So you might select investments and hold them in a tax-efficient Investment ISA (stocks and shares ISA) or a personal pension. Remember, though, that the value to you of these tax concessions will depend on your individual circumstances and eligibility, and that the beneficial rules around them could change in the future.
As you know, investments should always be considered as a minimum five-year commitment. But there are options if you don’t want to risk losing money or committing for that long, such as cash savings and fixed term deposit accounts. These accounts are considered to be safe investments, where the interest rate is guaranteed for the term of the deposit. Withdrawals are not permitted during the term however, or there may be penalties for early redemption.
If you can invest for at least five years, your portfolio might contain more traditional investments, e.g. a wide mix of shares (either held directly in stocks and shares or more likely equity funds) balanced with bonds and cash. In a typical economic cycle, it is hoped that five years may be enough to recover from downturns in markets and provide positive returns. Of course this isn’t a guarantee and you may still get back less than you invested.
If you have 20 or 30 years (or more) before your retire, you might want to consider riskier investments. That’s because they can offer potentially greater returns. But there’s also more chance of losing your money. Remember, there are no guarantees with investing.
As you get closer to retirement, you might sell off your riskier investments and move to safer options that aim to reduce the risk to your investment and returns.
Hopefully you can now see how your timescales can have a big impact on your investment decisions. Generally speaking, the longer you hold investments, the better the chance they’ll outperform cash (but remember that there are no guarantees, and you could lose money at any time).
Things to remember
- The value of investments can go down as well as up, so you could get back less than you invested
- If you’re unsure whether an investment is right for you, please seek independent financial and taxation advice.
Portfolio - a selection of different investments held by you.
Diversification - mixing a variety of investments within a portfolio with the aim of managing risk.
Dividends - part of a company’s post-tax profits paid to its shareholders. Usually this is paid as pence per share.
Asset classes - different types of investments with varying degrees of risk, e.g. funds, shares, gilts and bonds, cash.
Individual Savings Account (ISA) - a tax-efficient account that you can use to hold either cash or investments.