What is investing?
Put simply, investing is another form of saving, but instead of leaving your cash in a deposit account, where your money grows at the interest rate set by the account provider, you can invest your money with the aim of producing greater returns. Investing carries risks – your money isn’t as secure as cash savings and the value of your investments can fall as well as rise – but it has other potential benefits too.
How does it work?
Investing can help you beat the rate of inflation and may provide greater growth than saving in a cash deposit account, particularly if you invest over the long-term.
Remember, having accessible, secure savings in cash is still important. Before you’ve thought about investing and doing more with the cash you’ve spent time building up, you need to ensure you’ve got enough readily available cash that you can use for emergencies. The Money and Pensions Service (MAPS) recommends that you have three months’ salary available in savings in case of unforeseen circumstances.
How do you choose what to invest in?
There are four rules of thumb that you should bear in mind no matter how much you’re investing or what stage you’re at in your saving journey.
Investing is best when you think long term. It means your investments may be able to recover any short-term losses, as well as benefit from compound returns essentially returns on any investment returns you make.
Owning different types of investments through something like an investment fund (or having multiple investment funds) means if one doesn’t perform well, you could still receive the potential returns of others.
All investing comes with a degree of risk, which varies from investment to investment. You need to ensure you’re happy with the risks involved with whatever you choose to invest in.
Although just investing and saving in general can be goals in themselves, thinking about why and what you’re investing for can help you determine your risk, time horizon and what you invest in. It also means you’re more likely to commit to saving over the long-term, which is often the best approach when it comes to this type of saving.
What can you invest in?
Investment funds are an accessible way of investing. They work by pooling your money with other investors and then investing on your behalf. This way you don’t have to actually buy the different things that make up a fund – that’s done for you. Here are just a few different asset classes you can access by buying a fund through products like a stocks and shares ISA, junior ISA or personal pension.
Shares are essentially parts or a stake in a company. Funds can invest in individual company shares or they can track an index of companies, such as the FTSE 100 (the UK’s largest companies publicly listed on the stock market). With an index tracker you don’t just invest in one company, you track the performance of all of the companies that make up something like the FTSE 100. This means you have broader exposure without having to buy all of the underlying company shares individually.
Bonds are a sort of loan. Investors give their money to the bond issuer, such as a company or government, and then they are paid a fixed amount in return for investing their money. As well as investing in funds that pick bonds to invest in, you can also track bond indices.
Property can vary from residential property and commercial buildings to infrastructure like roads or wind turbines. You could consider including a property fund or investing in a fund that holds some property, if you want something that’s a bit more tangible in your selection of investments (known as a portfolio).
Combining different asset classes
Multi-asset funds essentially blend different types of investments together. This is so you’re not putting all your eggs in one basket and can benefit from the performance of different asset classes at once. Spreading your money across a variety of investments is known as diversification and is one way of managing risk.
Tax-advantages of using ISAs and personal pensions
ISAs and personal pensions both offer different tax advantages. Although we all have different tax circumstances, there are benefits everyone can take advantage of.
With stocks and shares and junior ISAs, any returns you make are protected from Capital Gains Tax and Income Tax and you can invest up to £20,000 across a number of ISAs (2018/2019 and 2019/2020 tax years). Please note that the junior ISA limit is £4,260 for 2018/2019 tax years, rising to £4,368 in the 2019/2020 tax years.
As for pensions, you automatically get basic rate tax relief on contributions which are added to your pension savings, and higher rate or additional rate tax relief may also be claimable through your self-assessment tax return if applicable. You can pay the equivalent of your entire annual salary each year (or up to £3,600 if that’s greater) and still get tax relief, although you’ll need to take into account the annual allowance. For most people this is £40,000 (2019/2020 tax year). When you decide to access your pension savings your annual allowance may be reduced to £4,000.
For more information on funds, you can watch our guide to funds video here or explore our full list of funds here. Our Investment Academy also has lots of content that can help you build up your confidence and understand the fundamentals of investing.