Investing can appear complicated. However, if you get a few important and relatively simple things right then you could be well on your way to success.
Many first-time investors place too much emphasis on deciding when to invest, worrying about economic or political events or trying to anticipate market peaks and troughs. This makes investing appear more difficult than it actually is. As 2016 has demonstrated, strong returns can be made amidst a turbulent backdrop and attempting to second guess market direction can be a fool’s errand. The reaction to both Brexit and Donald Trump’s victory in the US Presidential election was largely positive, confounding those who thought these events would derail stock markets.
Instead, focus on the basics. If you get a few important and relatively simple things right then you should be well on your way to success.
Set your priorities before investing
First consider your overall financial position including short terms debts or credit card balances you may wish to pay off. It is also important to identify your goals before investing. Are you investing towards a specific sum for, say, a deposit for a house? If this goal is five years or less you might consider lower risk assets and prioritise capital preservation – perhaps by simply accumulating cash in a decent savings account. If you are investing for a much longer-term goal such as a retirement you might consider riskier assets which fluctuate in value, but over the long term offer the prospect of greater returns.
When to invest
No-one can pinpoint exactly the right moment to put money in the market. Instead, don’t even bother thinking about whether the market is high or low. Monthly savings by direct debit from your bank can be a great way of combating stock market volatility. You can do this from £50 a month with an ISA, or £100 a month in a SIPP (Self Invested personal Pension). You’ll be averaging your purchase price over time, so dips in the market, particularly in the early years, could even work to your advantage.
Keep doing this over long periods (by which I mean 10 years plus) and the distracting highs and lows the stock market provides should cause you less concern. Time and patience are your greatest allies; you may be amazed how monthly savings coupled with good investment returns can build a sizable nest egg over time.
Where to invest
For the regular investor, funds (unit trusts or OEICs) may be appropriate. Other investments such as individual shares can be awkward, or costly to purchase on a monthly basis. Also, with a fund you’ll instantly gain some diversification – an important concept in investing. Diversification essentially means not having all your eggs in one basket. Funds typically invest in 50 to 100 shares, spreading your investment around so you are not reliant on any one company’s shares.
There are thousands of funds out there so trying to single out next year’s blockbuster is pretty much impossible. Again it’s a case of trying to stack the odds in your favour. Don’t pick dozens of different esoteric funds. One or a small selection of decent, broad-based funds will do fine when you are first starting out. Once you have chosen your investments, monitor them to see how they are getting on versus their peers – you can redirect your regular savings to a different fund or funds in the future if you feel you should. Passive funds or “trackers” are a simple option to reduce the impact of charges on your returns. These aim to replicate the performance of a particular market, for instance the FTSE 100, and because there is no fund manager or team employed to make stock selection decisions they usually come with lower costs.
For longer term investors equity income funds may be appropriate. These funds invest in shares of companies that pay high (and hopefully growing) dividends. Dividends are a share of the profits that companies make, and as a shareholder you are entitled to receive them. The fund collects the dividends from each of the companies for you and you can either choose to take the income or reinvest it to buy more units in the fund. If you don’t need the income, which you may not an investor just starting out, it’s better to reinvest them to “compound” your dividends. Buying “accumulation” units in the fund will do this for you.
With constant news about market developments it is easy to lose sight of the power of reinvesting dividends. Yet it is an important trend that is always on your side as a long term investor – and it means you can still make money from the stock market even if share prices don’t go up. With accumulation units, the income is reinvested for you in more shares, which means your holding could receive greater dividends in the future. This compounding effect is why equity income investors should have confidence in the future. However, while the stock market has historically been the best place to invest over the long term, all investments can fall as well as rise, especially over the short term, so you could get back less money than you put in.
When to sell
Ideally, you shouldn’t need to sell an investment until you have reached your goal and want to start taking money out. If you have chosen a good-quality fund and it performs well, stick with it. If it goes down don’t fret too much. If you are saving regularly and reinvesting dividends, a fall in the unit price means you are buying cheaper units. As long as the fund rises later on over your investment period (above and beyond average cost of units you bought) you’ll still make money.
Try and resist the urge to tinker. You might incur costs in doing so, which could eat into your returns. Check the investment is performing satisfactorily against its peers once a year or so.
A version of the above article by Rob Morgan was first published by Charles Stanley on 30th May 2017.