Monday 21st February 2022
What's it all about?
This article's designed to help you:
When you’re just getting started in investments, learning how to make your money work for you can be tricky. The investment world can feel like a dangerous place, full of strange rules and hidden threats. That’s why your first steps are the most important, and why just sticking to a few basic principles can do a lot to keep you safe.
So let’s get the Big Thing out of the way first. All investments have a certain amount of risk that comes with them. Even so-called “safe” options can still leave you losing money in real terms if the returns aren’t keeping up with inflation. There are no rock-solid guarantees that your investments will grow, so you need to go in with both eyes open.
For one thing, that means clearing out any outstanding debts you’ve been dragging around with you first. They’ll only weigh you down, and can easily wipe out anything you make from investing. Next - and no matter how obvious this sounds, it’s important enough to spell it out – don’t take risks with money you can’t afford to lose. Keep an emergency fund of cash you can easily get hold of in a pinch. Sudden costs like repair bills can hit you out of the blue, so tying up everything you’ve got in investments could leave you in the lurch with an expensive bill to pay. Every investment decision you make is going to need to factor in how much you can afford to lose – and whether you’ve still got enough easy-to-access cash to get you through a tight situation.
With all that said, let’s take a look at 7 of your main early investment options – starting with one so well known that people barely even think of it as an investment at all.
They're good for the most part
There’s a lot of good stuff to say about pensions. They’re great for minimising the tax you pay on your savings, and a simple, reliable system to build your retirement plans around. They also give you a lot of room to grow. You can get tax relief on up to £40,000 a year of contributions, or up 100% of your taxable earnings if that’s higher, with a tax-free lifetime limit of £1,073,100.
It’s already a great deal for most people, since it basically tops up your contributions by £20 for every £80 you pay in. If you pay higher rate tax, you can actually claim even more in a Self Assessment tax return. The very top earners making over £100,000 a year get an extra benefit on top, since they can use their pensions to stop themselves from getting a reduced tax-free Personal Allowance. If you’re making £100,000-£120,000 per year, you can find yourself paying out tax of up to 60%, so it’s important to make the most of opportunities like these. You can read more about this in our article, “How Earning £100k Affects Your Personal Allowance”
So overall, pensions sound great, right? Well, for the most part, yes. They do come with some drawbacks and limitations, though. The big one is that you really can’t get at your money throughout most of your life. You need to be at least 55 before you can make a withdrawal from you pension pot at all – and that age is set to go up to 57 by 2028. If you’re looking to cash in your investment a little sooner than that, you’re better off examining your other options before going all-in on a pension scheme. That brings us to...
Tax-free savings
Individual Savings Accounts are another popular option that most people never really think of as “investments”. The idea of fixed rate ISAs is pretty simple. They’re tax-free savings accounts that lock your money away for a set period in exchange for a set interest rate. You know what you’re getting, and you know when you’re getting it, so they’re usually considered pretty safe.
With a Fixed Rate ISA, you’re probably going to score more interest than you’d be offered with an easy-access one where you can take your cash out more freely. They’re easy to manage, too. You open your ISA, with a set limit on how much you can dump into it, then earn monthly or yearly interest on it until the term ends and you get it back out. Generally, the longer you’re putting your savings away, the more you stand to get in interest. When rates are low all over, though, there’s probably not a huge difference.
Again, these sound like pretty safe, low-hassle investments, right? Again, the answer’s yes – with a few quick words of caution. Your interest rate’s locked in from the outset. That means if rates in general rise, you won’t see the benefit. You’re also at the mercy of inflation. When the rate of inflation’s high and the cost of living’s rising, even top-rate fixed ISAs will struggle to keep the value of your investment.
ISAs, then, can be great when interest rates are high and inflation’s low, but that’s not always the financial climate you’re looking at and it’s all too easy to see any growth getting swallowed up.
Buy and Sell whenever you want
Now we’re getting into what most people think of when we talk about investing. Exchange Traded Funds are investments that track how a particular industry, commodity or other “index” is performing. It’s like holding a range of smaller investments in a basket with the risks and rewards spread out among them. ETFs are pretty easy to buy and sell whenever you want, just like normal stock. As a “marketable security”, an ETF has a given price attached to it and can be traded on a stock exchange.
ETF prices can obviously go up or down at any time, so the price you paid to buy in the morning could be different from the one you’d be charged in the afternoon. That’s one of the things that makes them different from other “mutual fund” baskets that can only be bought or sold at the end of the market’s day.
As well as keeping your overall risk level under control, ETFs make it cheaper to manage your investments. You’ll be paying less in commission to brokers than if you were buying each of your stocks one by one, for instance.
You've got a few options to match what you're hoping to do with them:
Diversify your investment
Like ETFs, index funds are a way of diversifying your investments so you don’t get badly stung by poor performance in any one area. The value of your investment is based on how a particular “market index” is doing. There are a few key differences between these and ETFs, though. The value of an index fund is only set at the end of the trading day, so they can only be bought or sold at that price. ETFs will often have a lower minimum “buy-in” – sometimes set even below the cost of a single share! Index funds, on the other hand, often expect you to lay down thousands of pounds to get involved.
ETFs also offer advantages in terms of tax when you sell them. When you decide to pull your cash out of an index fund, for instance, your fund manager has to sell securities to get your money. When you’re doing this to make a gain, the benefit gets passed along to everyone who’s invested in the same fund. This gets complicated, but the bottom line is that it can leave you owing Capital Gains Tax even though you haven’t actually sold any shares yourself. When you sell an ETF, on the other hand, you’re generally just swapping it for cash with another investor.
As for which is the better choice for you, there are a few things to weigh up. Obviously, comparing the “expense ratio” is a big part of that calculation, since the ongoing costs of keeping any investment is going to count against any growth you get from it. You’ve also got to think about commissions when you buy or sell – which will obviously matter more if you move your money around often and less if you don’t.
What's your level of risk
Keeping with the theme of diversifying your investments in order to protect them, let’s take a quick look at mutual funds. These are what you get when a bunch of shareholders have their money grouped together to be invested by a fund manager. The cash might be invested in bonds, stocks or other kinds of securities, and investing this way can get you access to investments you couldn’t have afforded to make on your own. The fund manager handles where the combined money actually goes, using their own research, experience and expertise to make investment decisions. You can decide for yourself what level of risk you’re prepared to accept, and balance that against your overall expectations.
So, how do mutual funds compare to ETFs and index funds? For one thing, the point of an actively managed mutual fund is to try and outperform the kind of “averaged-out” levels of growth you get with an index fund that automatically tracks a cross-section of a given market. You do pay for that personalised attention, though, so active mutual funds are often pricier than index-tracking ones. They’re also less predictable and, while you might manage to perform better than an index fund in the short term, it can be hard to point to any really consistent benefits over the longer term.
As you’ve probably noticed, one of the key tricks people use to reduce the risk and make bigger investments is to group up and pool their resources going in. This is what property crowdfunding’s all about. You team up with other investors to buy a property and split the ownership (along with the expense). You see this a lot with buy-to-let investors. They divide the costs going in, then split the rental income between them.
This can be a decent option, but like any other investment you need to think ahead a bit. Most of these deals involve splashing out for a management agent, unless you’re shouldering all of that workload yourselves. Also, depending on how the crowdfunding side of this was arranged, there may also be platform fees to cough up. Those kinds of costs all need to be weighed against the eventual rental income, along with any ongoing costs for property upkeep and so on.
The platform you use may be able to offer some educated guesses about the returns you can expect. However, keep in mind that predictions might not always match reality – and again, management fees can eat into the bottom line. On the other hand, the share of the rent you’re receiving isn’t the end of the story when you own property. If the place goes up in market value, your investment has grown. Once again, though, that’s not something that’s easy to predict, so investing in property might not be an ideal choice for people looking for steady returns. Rent only comes in if you can find tenants, after all, and you’re on the hook for most kinds of repair work.
The final thing to consider about property crowdfunding is how easy it is to get your money back out. Depending on your set-up, the platform you’re using might streamline this by letting you sell your share of the property directly through them. This can still take time, though – and make sure you check the deal you signed up to. Some platforms will require you to keep your money tied up for years before cashing out.
Low risk investment
We’ve touched on these before, but bonds are like a kind of fixed-term loan that you make to a government or company. There’s an interest rate established going in, which you’re paid throughout the duration of the bond. At the end of that time, the bond ends and you get your money back.
Bonds (sometimes called gilts when they’re from the government) have a reputation as a relatively low-risk type of investment, with the trade-off being that they usually offer fairly modest returns. They have a rating system to give you an idea of what to expect from them, running from AAA to D. The higher the rating, the safer the investment is expected to be. The name of the bond will usually also give you some basic information and expectations. For instance, a “4% RIFT 2028” bond will pay out 4% interest per year, then expire and return your money in 2028. You’ll often, but not always, find that you’ll be offered better interest rates on longer-term investments.
To get started in bonds, you can use the government’s Debt Management Office to invest in gilts directly. For corporate bonds, the London Stock Exchange has a Retail Bond Platform. To start investing there, you’ll need to have at least £1,000 to front up. Remember that you’re not buying shares in a company here. As we mentioned already, this is more like a loan you’re making. That doesn’t kill off the risk altogether, though. If the business goes under, for example, you could still be looking at some losses. You probably won’t stand to lose everything like a shareholder can, though. You’ll count as a creditor if the business becomes bankrupt, for example, so you’ll stand a decent chance of getting at least a good chunk of your money back.
If investing individually in fixed-income options sounds like too much work, you can opt for a collective fund like a unit trust. Collective bond funds work pretty much the same way as the other mutual funds we talked about above. Instead of your money going into one or more individual bonds with a fixed term, it gets spread out over potentially hundreds of different bonds and/or gilts. Generally speaking, you’re going to have to pay a fee for someone to manage all of this for you, which will drag your returns down, but you’ll be cutting back on the risk factor and won’t be tied to any specific expiry dates on your investments.
No bet is ever 100% safe
Getting into investment doesn’t need to be a blind dive into deep water, but there really is no such thing as a 100% “safe bet”. Don’t put money in harm’s way unless you can definitely live without it. Even if the eventual returns are good, a lot of the best options can mean locking your cash away for long stretches of time. Remember the all-important 50/30/20 rule: 50% of your income is set apart for essentials, 30% for non-essentials and 20% is saved. It’s that final 20% that you’ll be using for investments.
Keep checking back here for more money tips and updates. We’re experts at saving you cash and we’re always here to help. That’s the reason why you’re better off with RIFT.
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