THE ABCs of investing – finding out what’s what

Iona Bain

So if you’re thinking about starting to invest for the first time, one question will come rushing to the forefront of your mind. “WHERE THE HELL DO I BEGIN?!”

Gosh, there are SO many ways you can invest –  and TBH, I totally get why it can appear very daunting when you’re starting out. But the good news is that you’re not alone.

I have been there myself, and while my blog is committed to being a completely advice-free zone (since I am NOT a qualified financial adviser), I can certainly lay out the different options (well, the main ones you need to know about) and trust you to find the requisite info elsewhere and take the decisions you need to suit your own circumstances and sparkling personality.

And since we now have things like online investment shops (a bit like ASOS for shares) as well as more hands-on online investment shops (I talk lots more about the pros and cons of this HERE), there are no excuses. Why not make this a part of your inevitable New Year’s Resolutions orgy? And unlike the hardcore exercise regime or quinoa-only diet you’re planning, the investing habit is relatively easy to establish but will stay with you for the long haul. I’d be lying if I said the results are totally guaranteed, but history shows that investments do tend to outperform humble old cash in the long term and get us the returns we need to make the really big stuff happen in life (i.e. retirement).

And if you’re being REALLY canny, you can start investing money for goals that aren’t even that distant, such as your first home or seed capital for a dream business. Although I should point out that these goals should be more than five years ahead of you – otherwise, you won’t have enough time to ride the ups and downs of the market, and you raise the risk that you’ll end up with less than you began with.

Today, there are different investment approaches to suit different budgets and different patience levels for active trading. And then, of course, there are different attitudes to the effectiveness of so-called “star managers”. I have written before about how many active fund managers can fail to give you enough bang for your buck and cost more than so-called “tracker funds”, though picking a manager who DOES consistently nail things will help you surpass the returns you could make through passive investing. It is not my place to tell you which is better, but hopefully give you an idea of the facts so you can make your own call.

I am going to avoid one very talked-about area of investments right now – Bitcoin. I will return to this subject in subsequent blogs but crypto-currency is too complicated to cover here, and I would argue that it’s entirely unsuitable for first-time investors anyway. So that’s that.

cause-im-the-boss

So remember – the value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results. So let’s delve into this magical world, shall we? I can barely contain my excitement.
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Shares

In days of yore, the only way a private investor could directly buy shares was through a stock broker, who always wore red braces, had slicked-back hair and didn’t eat their lunches. (Okay, I *may* be stereotyping.)

You can still use a stockbroker but – yes, you’ve guessed it – it’s mostly moved online, innit. So today, you can build a whole portfolio of individual shares from your sofa/bed/toilet seat/work station/top of Mount Kilimanjaro (signal permitting). It makes me wonder what happened to all those red braces…(*sighs*)

This is basically about being your own fund manager, and although I avoid telling people what to do on this blog (hey, every individual is different, man), I do believe this strategy could be a bridge too far for the starter investor. You would need to back businesses you feel you know well, in sectors you feel are promising for the long-haul, and be prepared to do your research. If you tick these boxes, buying individual shares can lock in good dividends and offer capital growth.

You’ve gotta to understand the need for diversification, i.e. buying enough shares to insure against backing losers, and you’ve got to have the strength to act appropriately when a share falls sharply – either to ‘stop loss’ and sell or hang on for the longer term, depending on your assessment of the stock’s true outlook. If you are tempted to go down this path, you need to know the difference between defensive and cyclical stocks, as well as those ostensibly bought to give you an income versus those creating capital growth, and to build a portfolio of shares to spread the risks.

Open-ended funds

The fact remains that, despite gloomy headlines about “rip-off” investment funds, the best returns do come from those active managers with strong track records working in more specialist areas of investment, such as overseas markets or small and micro-cap companies. Investors who pick those fund managers and stick with them throughout their upward trajectory will achieve, on average, much greater returns than if they stuck to tracker funds.

However, there are three things to bear in mind. Firstly, it may be that you don’t necessarily need to be aiming for the best returns in the market (yea, you greedy guts!) as there could be a trade-off with higher risk that you’re not really prepared to take. Either active OR passive funds aiming just for a respectable, consistent return above the benchmark with a more cautious strategy may be a better fit for your investment time frame and goals (e.g. investing for a house deposit in seven years time…) Secondly, it is SUPER hard to find managers that consistently outperform the markets. And thirdly, the large number (if not the majority) of actively-managed funds do not justify their costs by delivering a better performance than a low-cost fund or exchange-traded fund which tracks the same investment area.

Investment trusts

Traded like shares, investment trusts are actually companies that list on the stock exchange. While they can seem complicated from the outside, there isn’t much you need to really get your head around beyond the fact that a) investment trusts can borrow to invest b) they have independent boards which can hold their manager’s decision-making to account c) they have active shareholders who can kick up a fuss if they don’t like the way things are headed (a bit TOO active sometimes, according to some commentators writing about this controversial turn of events).

Investment trusts have a refreshingly honest and easily track-able measure of potential returns – the gap between its share price and asset value. If the share price is below the asset value, the trust is at a discount – if it’s above, it’s at a premium. Ideally, you want to be getting into investment trusts when they are trading at a discount to the asset value, but for no glaringly obvious reason. This is because the share price should then rise as investors catch up and try to get in on the action, narrowing the discount and boosting returns. For this reason, I like investment trusts and believe they don’t get the rep they deserve (they are massively outnumbered by open-ended funds). But the flipside of borrowing AND of discount movement is that losses can be magnified too, so there is a big risk factor here to remember. Also, if we’re being really nit-picking, buy-sell ‘spreads’ and 0.5% stamp duty build in costs can be a drag on returns.

ETFs

Exchange traded funds, or ETFs, is all about passive investment, with no manager, in an index tracking any market, territory or asset. The array of ETFs available today is bewildering, from foreign currency to oil to Japanese equities to infrastructure. I’m surprised there isn’t an ETF tracking the companies that make the frocks for Strictly Come Dancing.

Costs ought to be low (certainly lower than active funds) with no stamp duty (a plus over investment trusts). They help you build that all-important diversified portfolio and some passive managers will whip up a portfolio for you in seconds based on a risk profile you provide. So it really can be ideal for you all lazy Daisies, a bit like buying a ready meal over cooking a meal from scratch. But if you don’t want a manager to build a portfolio for you, then you have to be in charge of picking the investments yourself. FYI – ETFs be more expensive than trading individual shares, while the dividends might also be lower. And if an ETF is what they call “thinly traded” – i.e. an asset that cannot easily be sold or exchanged for cash without a substantial change in price – you might find it very difficult to get out of the investment if you need to.

Fixed interest

Here, we’re talking about government (or sovereign) and corporate bonds that allow you to play it safe, at least compared to buying equities. They gave a moderate risk level, with a certain outcome if held to maturity, and possible gains (or losses) if traded. And if you’re not sure how to get a hold on this particular asset class, then so-called strategic bond funds will give you the diversification you need. And – just to mess with your mind a little bit more – you can also buy ETFs tracking bonds.

Sovereign bonds basically offer you a return in exchange for you lending your money to that government.  A country that’s gone a bit Greece or Venezuela will offer pretty whopping returns as the risks of lending are much greater. If interest rates go up, that’s *not great* for government bonds, because higher rates paid on cash make government bonds less attractive for investors. If you buy corporate bonds, they can become a liability in an economic downturn and bond funds can also be pretty dear.

P2P and crowdfunding

Ah, now P2P (peer to peer) or crowdfunding is probably something that’s already crossed your radar. P2P essentially refers to online platforms which offer returns for investing in the debt of small businesses. They promise relatively easy access to cash and rigorous credit-checking of clients, with lending spread across a wide basket of borrowers. There are MANY different kinds of crowdfunding, from equity to civic and donation-based, and I urge you to look at my previous articles on the subject because there’s WAY too much to go into here in just a couple of paragraphs! But basically, crowdfunding is about putting your money into a start-up cause or business, with varying promises for crowdfunders (e.g. an equity share or special merchandise).

The industry is still in an early phase compared to Grandfather Investment and therefore we don’t really know how this whole sector performs in a market downturn, so there are risks of businesses defaulting on their repayments, closing before they come to term or companies massaging their prospects to win over investors. P2P and crowdfunding platforms INSIST they do loads of due diligence to stop investors being lured into patsies, and P2P is much further down the risk spectrum than crowdfunding with their own compensation funds in the event of default, but regulation isn’t as tough as it could be. So there is a very real risk, particularly with equity crowdfunding, that you will lose your investment – possibly the highest risk option we’ve looked at in this piece.

Property

Property is the one asset most young people would love to get their hands on, but paradoxically find the most elusive. If a deposits for that first home are out of your reach, you can benefit from our seemingly never-ending housing boom through funds or ETFs focused on property, or a peer-to-peer platform specialising in either residential or commercial schemes.

The last of these is becoming particular popular among young investors as they tend to provide a greater return than cash without the daunting risks and choices associated with traditional equity investment. But just because property seems to more straightforward than other asset classes doesn’t mean there isn’t capacity to get things wrong. The commercial property market cycle can be difficult to understand and time correctly if you’re a first-time investor, and getting money out can sometimes be difficult as these tend to be pretty non-liquid investments. So while house prices might seem to keep going up, the prospects of an individual property, fund or scheme depend on many different factors, such as location and how well the investment is handled. Car canny.

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