Bad news always makes the headlines, while good news is rarely reported and, over the past 15 years we’ve seen constant negative headlines when it comes to stock markets. We’ve witnessed two huge market crashes, with the end of the tech bubble in 1999 and the recent financial crisis of 2008 resulting in almost 50% declines. Then every few months we hear of another company blowing up. The latest examples are Tesco, Balfour Beatty and Quindell, and there have also been the Madoff and Enron fraud scandals!
So it’s not surprising that most ordinary people view the market as a risky gamble, which may or may not pay off. However, for the most part, our stock market works well and has actually produced some good returns over the long term. Investing is also not nearly as hard as you might think. Anyone can do it, and be successful, as long as they understand a few basic principles.
The 10 tips
- First, pay off any high interest debt, such as credit cards or bank loans, before you even consider investing. This is less a principle and more a golden rule! There’s no point investing when you’re paying huge interest on debts.
- Then consider your goal and your investment time horizon. If you’re saving for a house deposit and plan to buy in the next couple of years, then investing in the stock market is probably not appropriate because a big fall in the market might prevent you from reaching your goal. The key point to remember is that the longer your time horizon the better chance you have of making money in the stock market. If you’re going to be investing for over 10 years you should consider some exposure to the stock market.
- Think about your risk tolerance and be honest. Some people just can’t handle the swings of the stock market and it causes them sleepless nights. If you’re one of these people you shouldn’t be investing in stocks. Be aware that the stock market will almost certainly go through a major crash in the future but it’s impossible to know when. Prepare yourself for this before you invest. Unfortunately many smaller investors sell out at the bottom of the market after a big sell-off and miss out on the subsequent rally. That’s exactly what you want to avoid.
- Buy a fund not a stock. Buying a single stock can be very risky, even if you hear a great tip from a mate in the pub! Choosing stocks that will beat the overall market is hard and requires a huge amount of time, energy and experience. Remember if you’re buying an individual stock you’re saying you know more than all the other professional investors in the market. So consider buying a fund instead. If one or two stocks in the fund go bust you won’t lose all your money. There are two types of fund, passive and active. Passive funds simply try and match the entire performance of a stock market as best they can. Active funds employ a fund manager who actively takes positions and tries to beat the market. It’s much easier to research a fund than it is a stock. Websites such as fundcalibre.com provide a list of managers who have historically been skilful, as well as performance data and free research on their favourite funds. As you become a more experienced investor you may decide to invest in individual stocks but you shouldn’t if you’re a beginner.
- Diversify. A classic investing mistake is when an investor puts all their money in a single stock, only for them to lose all their money when the stock crashes. By investing in a fund that makes many different investments, you immediately diversify and protect yourself. You can also diversify by region (UK, Europe and Asia, for example), company size and asset class – you don’t have to invest in stocks, you can also invest in bond funds or property funds, for example. Bonds are money that is lent to governments, corporations and municipalities in return for periodic interest payments. They have typically given a lower return, but they are generally much less volatile than stocks and, even more importantly, they often do well when equities are doing badly.
- Understand what your investment. Whatever sort of investment you choose, make sure you understand it. If it sounds too good to be true, it probably is! Check a fund’s underlying investments on the factsheet. The Madoff scandal happened because no one bothered to check what he was actually doing. Beginner investors may want to check that their fund is an onshore fund. An onshore fund protects you in cases of fraud to the value of £50,000 per fund group. Of course this doesn’t mean you’re protected if the value of the fund’s investments fall.
- Start small. You don’t need to be rich to invest. For example, at Chelsea Financial Services you can invest with as little £50. Even making a small investment will get you in the habit of saving and following it will help you to build up your financial knowledge.
- Consider monthly savings. You don’t have to invest all your money at once. One of the best ways to start is by investing monthly. By investing monthly you can invest gradually, enabling you to take advantage when prices fall. Putting a fixed amount into a fund every month, regardless of market behaviour, is known as ‘pound-cost averaging’. Monthly investing promotes the discipline of saving, whereby a small amount invested every month over several years can build into a sizeable nest egg.
- Get value for money. Charges matter and unfortunately many providers aren’t transparent. At Chelsea we only have our service charge (0.4% a year) and a Cofunds platform charge (0.2% a year). There are no other charges for anything else. Watch out for providers who take a minimum monthly charge or charge you for each transaction. There’s no point in investing £100 a month if there’s a minimum charge of £8 a month or if it costs £5 for each trade. Also watch out for the charges of the actual funds. Look at the OCF (ongoing charge figure) which includes the (annual management charge). An OCF of greater than 1% is very high and should be avoided in most cases.
- Don’t trade your funds – there’s a big difference between a trader and an investor. Don’t pay too much attention to noise in the media. Beginners should not trade their investments. This can be expensive and is usually pointless. A wise man once said that the stock market is a very efficient mechanism of transferring money from the impatient to the patient. Choose your initial funds carefully and then review them every so often. Once every six months should be enough.