Unsure where to start with investing? We take you through what's involved and what the returns and risks might be.
Investing your money is a big decision and it can be risky, but it can also make your money work harder. The more you understand about investing, the easier it will be to make investing decisions that suit you.
Investing is all about trying to grow your money and keep up with rising prices.
Investing involves taking some of your money and trying to make it grow by putting it into something, whether that's a company or an asset, that you think will increase in value.
But all types of investments carry risks. There are a few things to consider and questions to ask yourself before you dive in:
Are you ready to invest?
There’s no perfect time to invest so this is a personal decision, but you might want to consider investing if:
- You have enough savings to cover 6 months’ expenses.
Investing is all about the long game and there's always a risk you'll lose money. If you were faced with an emergency you may not be able to immediately access the money you’ve invested. That’s why it’s important to first make sure you have enough savings to cover 3-6 months’ expenses. These savings should be easy to access so keeping them in cash, such as in an instant-access savings account, is a good idea.
- You have long term money goals.
Deciding whether you should save or invest depends on when you think you’ll want the money. For short term goals like a new phone, it’s generally better to save in cash through a bank account or building society.
For medium term goals, like a new car, you could either save or invest. If you know you’ll need every penny and can’t risk losing any of your money, then saving is usually the safer option. If you have more flexibility and are prepared to take a bit more risk, then investing may help you get a greater return.
For longer term goals, like your retirement, investing could be the better option. This is because over time, inflation can seriously affect the value of cash savings. If you choose solely to save all your money, it’s likely that your hard-earned savings will lose value over time.
Investing is taking some of your money and putting it into financial schemes, shares, property, or a company in the hope of getting a profitable return.
What investments can you make, how do they work and what are the risks?
There are four main types of investments that you could make, these are: shares, property, bonds and cash. You could also invest in things like foreign currency, collectibles and even commodities such as gold or oil.
The different types of investments are known as ‘asset classes’. When you make more than one investment, the various assets you own are known as your ‘investment portfolio’.
From any investment the hope is that you’ll eventually make a profit. This is known as the ‘return’. The size and form of your returns will depend on the size and type of investment you make, how successful it is, and on external factors like the economy.
Alongside the possible returns, all investments carry risk. ‘Risk’ is the chance that an investment you make won’t offer the returns you expected. Put simply, it’s an indicator of the potential for losing money.
Every type of investment will offer you returns in a different way, and the risks attached vary between each type:
Shares are when you buy a stake in a company. This means you’ll effectively own a small portion of that company.
Returns: When you invest in a company by buying a share, you’ll get a percentage of the company’s profit in return. This is known as the dividend. Shares tend to provide the best returns in the long term, so the longer you have a share the more returns you are likely to see.
Because shares are bought and sold, they’ll have a price. If the price of the company’s shares increases then you could make a profit by selling yours. But this forfeits any future returns you may have made.
Risks: Shares often offer the highest returns but they do carry risk. Share prices rise and fall all the time. This could be due to the changing performance or value of the company, or the performance of the economy as a whole. If share prices fall, then the value of your investment falls too. If you need to sell your share when prices are low, then you may also lose money.
This is where you invest in a physical building, which could be residential or commercial.
Returns: If you let your investment property out, this will come in the form of rent. Hopefully the value of the property you buy will also increase over time, so if you choose to sell it you can also make a profit.
Risks: Property prices do tend to increase, but this isn’t always the case. For example, in 2008 when the financial crisis hit, house prices fell by nearly 16%.
Bonds are effectively a loan to either a company or to the government. The loan will be for a set amount of time and will have a set amount of interest. After this time the company will repay your loan to you.
Returns: This is in the form of interest. Bonds work in a similar way to any normal loan, but because you are the lender you get the interest. Here’s an example to show how it all works:
A company may offer a £10,000 bond for 15 years with a 5% interest rate. This means that you will be lending the company £10k for 15 years. Every year over this period you’ll get paid 5% of your investment. At the end of the 15 years, you’ll get the initial value of the bond back, so here it would be the 10k.
Risks: Bonds are usually less risky than shares because interest rates don’t change every day. Also, bonds have a fixed rate of return each year. But if you buy a bond with a higher interest rate it is likely to be much riskier, even though the returns could be greater. This is because these companies are less credit-worthy so to attract investors, they have to offer higher returns. But because they are less reliable there is a bigger risk that the value of the shares could change dramatically, or even that the company could go under.
This is the most straightforward type of investment and the good news is, if you’re saving money in a product like an ISA, then you are already doing this.
Returns: This will be in the form of interest, but generally it will be much lower than the other types of investments.
Risks: This is the least risky type of investment as you are far less likely to lose money. But money in cash products risks losing value due to inflation.
All investments are risky, but some are riskier than others
Typically, the higher the rate of return, the riskier that investment will be. You may see large gains but equally you may experience big losses.
So how can you lower the risks?
1) It’s a good idea to diversify
This means spreading your money across different types of investments.
Spreading your investments across the different types of asset classes is less risky than only investing in one type. By diversifying your investments, it can help lower the overall risk of your portfolio. If one investment doesn’t work, then you’ll have others to fall back on.
2) You need to manage risk levels as time goes by
Generally the longer you invest the less likely you are to lose money. In the short term, investments may have a much bumpier ride and the returns may be lower so only keeping investments for short periods makes them riskier.
How to go about investing
The first thing to do is define your goals. What are you investing for? Do you want to make sure your money keeps up with inflation? Or do you have a more specific goal in mind? Thinking about this will help you decide what type of investments to make.
It’s also really important to consider the worst case scenario. Where would you be if your investment fell in value and you lost money?
If you need help you can go to a financial advisor. A regulated financial advisor will ask about your circumstances, goals and attitudes to risk. Then they can recommend suitable (and affordable) possible investments.
There are even a few apps that can help you invest:
- Nutmeg. Nutmeg is an online investment service that will help you set up your portfolio, without needing any prior knowledge of the stocks and shares market.
- Acorns and Moneybox. These are both ‘micro-investing apps’. They’ll round up your spare change and then invest it in a number of companies. A big benefit of these is that you can take out your money at any time.
And that’s investing. If you're looking for a way to grow your wealth it could be for you. But don't forget to think about those risks. See it’s definitely not as complicated as you thought.