How to start investing: a beginner’s guide
Have you finally decided to start investing? This guide answers some of the pressing questions you may have in the beginning of investing journey.
How to start investing
Contrary to popular belief, investing is not just the preserve of the rich, and is accessible to anyone willing to grow their wealth. There is no minimum starting amount in investing, and you can begin with as small as £250, building your capital over time. This guide will give you all the information you need when starting off your investing journey.
What is investing?
Investing is the act of buying securities such as company shares, fixed-rate bonds, commodities, index funds, and other investment vehicles, expecting their value to grow over time. The goal of investing is to create long-term wealth by building a portfolio that would maximise profits from capital gains and dividends while minimising the risks.
Why should you invest?
Investing is suitable for everyone, whether you have a large amount of capital or are starting with small amounts. The key benefit of investing over keeping money in savings is that the interest rates in banks are at record lows. For instance, the Bank of England’s (BoE) current base rate, which is a benchmark for other lenders, is 0.1%, which means the annual return for every £100 is only 10 pence a year.
Meanwhile, inflation is running ahead of interest rates and eroding the buying power of cash-saving pots. For example, according to the Office for National Statistics (ONS) UK Composite Price Index, prices in 2019 are 150% higher than in 1989, with the real value of the British pound decreasing by 3.1% per year on average during the 30 years. In other words, the purchasing power of £100 in 1989 equals to £250 in 2019. Therefore, by keeping your cash in savings you are actually losing its value.
Stocks, on the other hand, have a reasonable chance to keep in pace with inflation. In the US, for example, the stock market has enjoyed a strong uptrend over the past century. A £100 put in S&P 500-tracking mutual fund in 1989 with dividends reinvested would grow into £1785 in 30 years, excluding the account maintenance costs. According to the BoE base rate data, the same amount put in a UK saving account in 1989 would turn into £364 in 2019. Investing in S&P 500 creates £1,421 or 390 % in additional profit over the 30 years.
What can you invest in?
Traditionally, there are three main asset classes: cash and equivalents, company shares, and fixed-income bonds. Yet today investors can also get exposure to commodities, real estate, currencies and more in their asset class mix.
Investing in stocks
When buying a share or a stock of a company you are buying its equity ownership. That means you now own a slice of the firm and are entitled to capital appreciation and dividends.
Dividends are a form of reward to the shareholders for putting their money into the company and can be paid in cash or additional stocks. Dividend payments are distributed from the company’s earnings, and not every firm can afford or prioritise dividend payments. Investors are advised to reinvest their dividends further to increase capital gains.
Unfortunately, in the current economic environment with many companies hit by the pandemic, dividends are being slashed to reserve money and weather the storm. According to Link Assets, UK dividends plunged by 57% in the second quarter (Q2), and are predicted to fall by 40% in 2020.
It’s important to note that stock prices go up and down, and there is no guarantee of future returns. Fortunately, over the past century the UK equities have experienced a strong uptrend. According to the Barclays Equity Gilt study £100 invested in equities in 1899 would now be worth around £2.7m, as compared to £20,000 when invested in cash, or £42,000 when invested in gilts. Yet shares are still considered ‘high-risk’ assets. Unexpected events outside of your control can affect a company’s performance and bring volatility to the share price. There are ways to manage these risks such as diversification, which will be discussed later in this article.
Investing in fixed-income bonds
The first official government bond was issued in 1693 by the BoE, to raise money for a war with France. More than 300 years later bonds are used by investors around the world. In its essence, bonds are loans issued by a government or a company to bring new funding. Investors who buy into bonds receive fixed interest rate paid either monthly or quarterly for the loan duration. At the end of the period, which can vary from three months to 20 years, investors receive their money back.
Bonds sit up higher in the capital structure than stocks, meaning bondholders get paid first, which makes bonds a safer investment than shares. Yet as with any loan-based investment, there is still risk that a company or a government may fail to pay back at the end of the term. Therefore, it is crucial to review the risk status of a bond via credit rating company before buying. The best bonds would have a credit rating including and above A and would offer regular inflation-beating returns.
Investing in commodities
Commodities are tangible assets you can invest in to diversify your portfolio. They vary from precious and industrial metals such as gold, silver and copper, to energy markets such as oil or natural gas. You can get direct exposure to a commodity by buying Exchange Traded Funds (ETFs), which will be explained in the next section, or you can invest in commodity miners and producers. Commodity market varies significantly, and you should do your research before getting in.
Exchange Traded Funds (ETFs) and index investing
Indices are baskets of securities that replicate certain areas of the market. For example, many benchmark indices mirror the performance of the biggest publicly listed companies in a country, such as FTSE 100 in the UK, DAX 30 in Germany, or CAC 40 in France. Index-tracking funds reflect the weighted price of the companies included in the index.
Index investing came into play in the 1970s, when Vanguard issued the first ever mutual fund that tracks S&P 500, currently known Vanguard 500 Index Fund. The appetite for the new type of investing was strong, yet the mutual funds were expensive and illiquid, as many required minimum investment amounts. The new solution was needed that would be more accessible to general investing public.
In 1993 State Street Global Investors issued the S&P 500 Trust exchange-traded fund (ETF). ETFs are similar to mutual funds in the way that they can mimic indices and contain multiple underlying assets, but there are some principal differences between the two. As their name suggests, ETFs trade on exchange on a per share basis with the price fluctuating throughout the trading session. Meanwhile mutual funds trade only after the market closes and tend to have higher commission fees than ETFs. The constant trading makes ETFs more liquid as they are easier to get in and out.
Since 1993 the range of available ETFs exploded with almost 7,000 listings in 2019 according to Statista, and ETF flows exceeded those of mutual funds in 2003. ETFs have become one of the most popular investor vehicles as they cover a wide variety of sectors and contain all types of asset classes, including stocks, bonds, commodities, real estate, currencies and international investments. For example, Dow Jones Global Real Estate Fund for property exposure, or FANG+ ETF for the leading US tech companies. There are also inverse ETFs, which trade in the opposite direction, and leverage ETFs that magnify results. Using ETFs investors can build a diversified portfolio with a lower capital and fewer trades than they would have been required in the past.
One of the key reasons for ETFs success is that they are keeping up with trends. For example, after the commodity boom of 2003-7 numerous new commodity focussed ETFs have been launched in the market, such as Xetra Gold. Recently there have been a number of new ETF listings that adhere to environmental, social and governance (ESG) investing principles, such as ESG Aware.
You can use IG ETF screener to filter down the available ETFs. You can choose country specific trackers, and invest based on geography, or search for industry-focused, currency or commodity ETFs.
Hands on vs managed investment portfolio
The first question you should ask yourself when starting off your investing journey is whether you want to create a portfolio by yourself or prefer to pay a commission fee to a wealth manager. The decision here is around whether you have the time and willingness to do your own research and develop an investing strategy, which requires commitment, or you would prefer to pay a professional to do the work for you, which you can do with IG Smart Portfolios.
Alternatively, if you are all about hands on approach, you can manage your own investments on the IG’s share dealing platform that offers US shares commission free, and UK shares for as little as £31 per trade. With no sign up or exit fees, we can offer the perfect home for your portfolio.
Tax efficiency in investing
In the UK you have to pay capital gain tax on the profit you make when selling an asset after it had increased in value. This means you have to pay tax on any profit from your investments. Fortunately, there is a way around it. With Stocks and Shares ISA you have a yearly allowance of £20,000, which you can invest tax-free.
Risk tolerance and asset allocation
Investing is seen as a long-term capital growth strategy and is different to trading, which is benefiting from short-term price fluctuations. When investing in the stock market, it is recommended that you commit to your investments for at least five years for any significant return.
All investing involves risks. Although historically there is an uptrend in the stock market, black swan events such as the coronavirus pandemic can cause markets to crash, depreciating the value of an investment portfolio. Although the crash can cause a lot of distress, the mature markets, such as S&P500 and Dow, tend to recover. Therefore, it is important to have the time to weather the storm and not cash in at a low price and lose money.
The general rule of thumb is that the percentage of stocks in your portfolio should equal roughly to 100 minus your age. For example, if you are in your early 30s, you should have around 70% in stocks. On the contrary, someone who is soon to retire and would need their money in less than five years would be advised to keep it in less riskier assets, such as cash or bonds, as they don’t have the time to ride out market dips.
Diversification is a risk management strategy that involves getting exposure to different asset classes and investment vehicles to limit the risk of losing money. The idea behind diversification is that you should always keep your eggs in different baskets to not risk breaking them all at the same time. Similarly, by keeping your money in different places you won’t lose it all if any of the assets gets in trouble.
You can diversify by exposing your investment portfolio to different asset classes, regions and industries. You can do it by buying into ETFs, or individual stocks, commodities and bonds.
Pound cost averaging
Pound cost averaging is a strategy that entails investing equal amounts of money in the same asset at regular predetermined time intervals regardless of where the price is. The amount of stock you could buy with the same amount of cash would vary time to time depending on fluctuations in the price.
Instead of trying to time the market and invest a lump sum, the strategy minimises the risk of investing at the wrong time and lessens the impact of volatility. Pound cost averaging is especially rewarding for beginners who start at a small stake as it allows them to build capital over time. To execute the pound cost averaging strategy simply set a certain amount you’d like to invest monthly, weekly or quarterly and set a regular instalment into your investing account.
The strategy is powerful during a bear market, when the share prices are falling. In this scenario, it allows you to buy at low points, or buy the dips, without the fear of investing at the wrong time. On the other hand, the strategy is disadvantageous in a bull market, when the share prices are rising, as the same amount of investment would bring you fewer and fewer shares over time. Other downsides include less in dividends payments, and extra costs in commissions.
How to start investing: the bottom line
After learning about different asset classes, strategies and core principles, you are now ready to start investing. We hope that this article helps you feel more confident in the beginning of your investing journey. Remember that investing is a learning process, and you should research further to succeed. All investing contains risk, and your investing style must match your personal needs, risk tolerance, and timeframe.
How to start investing with IG
- Create your live account with IG in minutes
- Choose IG Smart Portfolios, which is managed for you, or share dealing, if you prefer a hands on approach
- If you choose share dealing, make sure to do further research on how to diversify your portfolio and manage your risk
- If you choose IG Smart Portfolios, we will ask you some questions about your risk tolerance
- Invest a lump sum and/or set up a regular instalment to fund your account
1Trade in your share dealing account three or more times in the previous month to qualify for our best commission rates. Please note published rates are valid up to £25,000 notional value. See our full list of share dealing charges and fees.
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