What is investing and how does it work?

​​​The fundamentals of investing explained

​Investing is fundamentally about putting your money to work with the goal of generating financial returns over time. Rather than letting cash sit idle in a current account, investing involves purchasing assets that have the potential to grow in value or produce income. This process allows you to build wealth and achieve long-term financial objectives.

​The core principle behind investing is accepting calculated risks in exchange for the possibility of higher returns than traditional savings accounts offer. When you invest, you're essentially betting that the assets you purchase will increase in value or generate income through dividends, interest payments, or rental yields from property investments.

​Time plays a crucial role in successful investing. The longer you hold investments, the more opportunity they have to grow and compound returns. This is why many financial experts recommend starting to invest as early as possible, even with small amounts, to harness the power of compound growth.

​Understanding your risk tolerance is essential before beginning any investment journey. Different investments carry varying levels of risk, from relatively stable government bonds to more volatile individual company shares. Your age, financial situation, and investment goals should all influence your risk appetite.

​Different types of investments you can make

​Shares represent ownership stakes in companies and offer the potential for capital growth and dividend income. When you buy shares, you become a partial owner of that business and benefit from its success through rising share prices and potential dividend payments.

​Exchange-traded fund (ETF) provide an efficient way to invest in a diversified portfolio of assets through a single purchase. These funds track various indices, sectors, or themes, allowing you to spread your investment across hundreds or thousands of companies with minimal effort and cost.

​Bonds function as loans to governments or corporations, offering regular interest payments and the return of your initial investment at maturity. They're generally considered less risky than shares but typically provide lower potential returns. Government bonds are usually safer than corporate bonds but offer correspondingly lower yields.

​Alternative investments include property, commodities, and more sophisticated assets like private equity or infrastructure projects. These can provide portfolio diversification and potentially higher returns, but often require larger initial investments and may be less liquid than traditional shares and bonds.

​Key investing principles for beginners

​Diversification stands as one of the most important principles in investing. By spreading your money across different asset classes, sectors, and geographical regions, you reduce the impact of any single investment performing poorly. This approach helps smooth out volatility and protect your portfolio from significant losses.

​The concept of compound returns can dramatically boost your wealth over time. When your investments generate returns, those returns can then generate their own returns, creating a snowball effect. Even small, regular investments can grow substantially over decades thanks to this compounding effect.

​Regular investing, known as pound-cost averaging, involves investing fixed amounts at regular intervals regardless of market conditions. This strategy helps reduce the impact of market volatility and removes the emotional element from investment decisions. You'll buy more shares when prices are low and fewer when they're high.

​Understanding fees and charges is crucial for long-term investment success. High fees can significantly erode returns over time, so choosing low-cost investment platforms and funds can make a substantial difference to your wealth accumulation.

​How investing differs from saving and trading

​Saving typically involves putting money in cash deposits or low-risk accounts to preserve capital rather than grow it. While savings provide security and liquidity, they offer minimal returns and may not keep pace with inflation over time. Investing, conversely, accepts higher risk for potentially greater rewards.

​The time horizon for investing is generally much longer than saving. While you might save for a holiday or emergency fund over months or a few years, investing works best over decades. This longer timeframe allows investments to ride out market volatility and benefit from long-term economic growth.

​Trading involves frequently buying and selling assets to profit from short-term price movements. Unlike investing, which focuses on long-term wealth building, trading requires active monitoring and quick decision-making. Most beginners find investing for beginners more suitable than active trading.

​Investment returns come from two main sources: capital appreciation (your investments increasing in value) and income generation (dividends, interest, or rental income). Savers rely primarily on interest payments, while traders focus mainly on short-term price movements rather than long-term growth.

​Getting started with your first investment

​Before making your first investment, establish clear financial goals and determine your investment timeline. Are you saving for retirement in 30 years, a house deposit in five years, or building general wealth? Your timeline will influence which investments are most appropriate for your situation.

​Assess your current financial position and ensure you have an emergency fund covering three to six months of expenses before investing. You should also pay off high-interest debt, as the guaranteed saving from eliminating expensive credit card debt often exceeds potential investment returns.

​Consider starting with broad market index funds or diversified ETFs rather than individual company shares. These provide instant diversification and are ideal for beginners who want market exposure without the complexity of researching individual companies.

​Determine how much you can afford to invest regularly without affecting your day-to-day living expenses. Even £25.00 or £50.00 per month can grow significantly over time through compound returns. The key is consistency rather than the initial amount you can afford to invest.

​How to start investing today

​Research is fundamental before making any investment decisions. Learn about investing through reputable sources, understand different asset classes, and familiarise yourself with basic investment concepts like risk, return, and diversification.

​Choose between investing directly in individual companies or using funds and ETFs for diversification. New investors often benefit from starting with broadly diversified funds before potentially moving to individual stock selection as their knowledge and confidence grow.

​Choose the amount of money you'd like to invest, whether that's a specific pound amount or a number of shares. Consider setting up regular monthly investments to take advantage of pound-cost averaging and build your portfolio steadily over time.