The first thing to consider before embarking on any new investment or savings plan is why are you doing what you are doing. What are your goals? Are they long term or short term?
Yes, you want more money. But why do you want it?
Why you want money determines what you should do with your money.
Do you have a short term goal like buying a new car, going on a fancy holiday or paying for a wedding?
Do you have a longer term savings goal, like saving towards a house deposit or university fees for your new born child?
Are you seeking a higher income in retirement?
Or are you just looking to start investing your disposable income to set yourself on the path to financial freedom?
Short term money saving goals are typically better suited to saving via a standard UK bank account, whereas investing is typically better suited to meet mid and long term goals.
You often hear people talking about investing in shares because equity markets will always rise in the long term. However, equity markets can also suffer significant corrections and therefore investing in shares would generally be an odd decision to meet a short term savings goal.
So the best advice is to think about when you will need access to your money. If you may need your money at short notice, you may be best suited to putting your money in an FCFS protected bank account. Your money will earn less interest but money is protected up to £85,000 per FCFS protected bank account.
If you want to save for a house deposit over a five year period, you can potentially take a more mid-term view and your disposable income may be better invested in equity (i.e. individual shares, funds, robo investment platforms) or debt markets (e.g. corporate bonds, peer-to-peer lending).
If you are looking to retire in 20 years, you are looking at a true long term investment horizon. You could consider the aforementioned investments or perhaps investing in brick-and-mortar with a buy-to-let investment.
Why does it matter if I save or invest?
Typically, people invest their money to generate higher returns than they otherwise would if investing in a bank savings account. Investing offers the potential for higher returns, because you are taking more risk with your money.
Have you ever thought about what happens to the money you deposit into your bank account?
When you save money into a bank, the bank invests that money in various types of loans and generates its profit based on the margin between the interest rate they are lending at and the savings rate they are paying savers.
However, because the bank needs to maintain a capital buffer (to ensure sufficient liquidity) and FCFS protection (which protects cash up to £85,000 per account), the returns offered are lower.
The most important investing concept to understand is the time value of money.
What is the time value of money?
The time value of money simply refers to the indisputable fact that money now is worth more than money later.
Having £1,000 today is not the same as having £1,000 in three years time.
Why not? The impact of inflation and compound interest.
The simplest explanation of inflation is that the price of goods rises, on average, over time. Something that costs £1,000 today, might cost £1020 in one years time (a price rise of £20, or 2.0% inflation) and even more in three years time.
If you were given £1,000 today, you could invest or save that money and generate a return on your capital. For instance, if you could achieve a 5.0% interest rate, then in one year, you would have gained £50 in interest payments, leaving you with £1,050.
After another year, your pot would grow by a further 5%, but this time, your savings pot is bigger at the start of the year, so your savings interest in year 2 would be £52.50, and in year 3, £55.12. After 3 years, you would have a total of £1157.62 – a gain of £157.62. This building up of investment gains as the capital pot grows is called compound interest.
You may have heard the sayings “money never sleeps” or “the rich get richer whilst they sleep” or “money makes money”.
All three are true, because of the compound effect. If you have more money saved, your money will make more money compared with someone else who has a lower capital pot.
This means that the sooner you start investing or saving, the better. There’s no time like the present.
So what are the best investment options?
There are hundreds of potential investment options ranging from standard equity market investments to classic cars and fine wine.
This investment guide covers most of the core types of investment: equity investments (shares and funds), fixed income (corporate bonds, gilts), property investments, peer-to-peer lending and other types of lending such as physical gold.
Once you have set yourself an investment goal and understand your investment time horizon, you need to consider how hands-on you want your investments to be, your risk appetite and your personal tax circumstances.
When investing in shares for example, do you want to invest in individual shares with the increased administration of following the companies performance and increased risk of fluctuations in share price?
Or, would you rather invest in a managed fund or index tracker through a platform like Fidelity. Read our post on the advantages of global equity trackers to understand the key differences between managed funds and index trackers.
Or, perhaps a robo-investment provider like Wealthify or Nutmeg, which you will need to monitor far less frequently.
Keeping track of your investments
Once you’ve started investing, it’s important to keep track of where you have invested your funds and to monitor your investment performance.
This is important because you don’t want to forget where your money is and you will want to understand which investments are making the best returns.
I personally monitor my investments on a Spreadsheet application on my phone. Such applications are available for both iOS and Android.
