At Holborn, we encourage first-time investors to look beyond the jargon and see through the myth that investing is the domain of the super-rich or risk-hungry. Maybe your idea of a safe investment is a tin under the bed with a lock on it? In today’s uncertain times, maybe you have the right idea! But either way, investing doesn’t have to be daunting.
Investing can be ethical, exciting, it can reflect your attitude toward risk, and be as simple as you choose to make it. Grasping some simple financial terms and understanding the main investment types can arm you with the confidence you need to change your relationship with your money, and make it work harder for you. We break down some key terms to reveal what you need to know about investing:
These are not evening classes for the student investor (!), but simply another term for investment types. There are four main asset classes:
Shares: you invest in a stake in a company – a unit of ownership – that entitles you to a share of the profits in the form of dividends.
Savings: the money you put into a bank account, building society or pension fund.
Property: you invest your money in a building (residential or commercial).
Bonds: also known as fixed-interest securities, you essentially loan your money to a company or government.
Attitudes to Risk
What sort of risk? We’re not talking here about leaving the car for an extra half hour past the expiry of the parking ticket, or chancing to drive over the speed limit without being caught (though these things in themselves can give you important clues to your personal relationship to risk in general).
Rather, a good place to start when figuring out what type of investment works for you (and an important conversation for you to have with your IFA) is about how much risk you want to take with your money. It’s safe to say that very few people want to gamble with their savings, but it is important to understand that there is no such thing as a “risk-free” investment. Even money you place into a secure deposit (such as a savings account) risks losing value in real terms (ie what you can buy with your money) over time. However, the amount of risk varies considerably between different kinds of investments.
Understanding yourself, and your own priorities, is a necessary starting point in your investment journey.
Most people would agree that diversity is a good thing in general. The same rule applies to your investments. Having a range of investments across asset classes can be advantageous but you can also “diversify” like this within asset classes themselves. For example, when buying shares you could invest in both large and small companies, UK and overseas and across different sectors.
If you have all of your cash in one single savings account, or all of your shares in one single company (your employer for example), it is probably a good idea to think about diversifying your investments.
Not the large black folder you carried about as a teenager boasting your artistic endeavours, but the term used to refer to the group of investments you have!
Wrappers: ISAs, LISAs, and SIPPS – ways to save
Imagine your money as your favourite chocolate bar. To prevent it from being nibbled by the tax man you can protect it with a variety of tax efficient wrappers (UK):
ISA – Independent Savings Account: There are two types of ISA – a cash ISA or a stocks and shares ISA – and at present you can invest up to £20,000 a year in ISA wrappers.
LISA – Lifetime Individual Savings Account: This is a bespoke ISA for the under 40s looking to save for a new property or retirement, or a combination of the two. You can save up to £4000 a year, up to the age of 50, to which the government will add 25%. So if you invest the full amount of £4000, the state will contribute £1000.
SIPP – Self Invested Personal Pensions: You can invest up to £40,000 a year with substantial tax breaks within a SIPP wrapper. You are restricted with this type of investment in that you can only access your funds from the age of 55, and although the initial 25% is tax free, you’ll be taxed on the withdrawal of the rest.
Stocks and Shares 101
Though these terms are often used interchangeably, there is a difference: the “stock” of a company is sold in units called “shares”, which entitle you to a share of the declared profits in the form of dividends.
Understanding a couple of key terms can help you feel more in control about how you to choose to invest your money.
Funds: Many people choose to invest in funds. Funds allow you to pool your resources with other investors in order to buy shares in lots of different companies. They are a good way to ensure that you have diversity in your portfolio. There are two main types of funds.
Tracker Funds (or Passive Funds) essentially track the performance of a particular market (usually indexes such as the FTSE 100 or the Dow Jones). When an index rises, the value of your fund rises, when it falls, your fund decreases. Tracker funds are attractive to some for their low cost and simplicity.
Active Funds generally require the guidance of a fund manager who will select stocks that look set to go up in price and actively manage the investment according to the rise and fall of the share prices and the general performance of the stock market. Active funds offer a more versatile and dynamic approach to investing, although they generally come with higher fees (due to the need for management).
Dividends: Generally the part of investing that everyone looks forward to. Dividends are the shared profits received by shareholders usually in the form of cash payments. Understanding how and when your dividends will be paid is an important part of your investment planning. Interim dividends are paid six-monthly and final dividends are paid at the end of the year. Some shareholders may receive their dividends in the form of shares.
Bonds: Simply put, bonds are a type of loan and are generally issued by governments and large corporations in order to borrow money. Bonds are often referred to as fixed-interest securities as the lender can anticipate the exact amount they will receive if the bond is held until maturity. Bonds offer lower risk investments (if a bankruptcy occurs, bondholders must be paid from a liquidation before any shareholders receive anything) though they do not offer the potential benefits of stock rises and a company’s profitability.
At Holborn we believe that clarity is at the heart of any financial relationship. We recognise that the key to understanding your investment needs is first and foremost to understand you, the individual.
Your IFA can help you take a holistic approach to your finances and future planning and help you feel empowered about your investment choices.