There has always been a common misconception amongst the general public that investing in the stock market should be left to industry professionals, with inexperienced investors lacking the necessary knowledge to successfully engage in the trading of shares. This notion could not be further from the truth. Investing in the stock market should be something everyone feels they are able to do. Our investing for beginners guide will help to get you started.
Although there is always a certain level of risk associated with investing in the stock market, it can be a great place for individuals to place their long-term savings. In periods of high inflation and low interest rates, such as now, those who invest in stocks and shares are likely to yield more attractive returns than those who leave their funds in a standard savings account.
Our Investing for Beginners Guide aims to build the foundations for inexperienced investors to start investing in the stock market and construct long-term portfolios based on their own unique investment objectives.
#1 Why you should be investing
Cash held in a savings account is generally losing value. Here’s why
With interest rates currently sitting at all-time lows and intense inflationary pressures dominating the domestic economy, money kept in a savings account is steadily losing its value. This means that, although the nominal figure of your savings is not decreasing, the real value of this money diminishes each day. For example, if an individual was to place their money in a cash account earning the current UK interest rate of 0.75%, its real value would reduce by 7.25% each year because the domestic inflation rate stands at 8% per annum.
Investing in the equity market, on the other hand, has the potential to generate rate of return that exceed the rate of inflation, thus adding to your wealth both in nominal and real terms. If investing is performed smartly and safely, it is a great way to grow your wealth over the long term and build an income for the future. This gives you greater financial flexibility and provides a degree of long-term financial independence.
#2 When should you start investing?
Don’t think about timing the markets, start as soon as you can..
Over the past few months, stock markets around the world have suffered from extreme volatility. Concerns about soaring inflation, rising interest rates and the general health of the global economy following the Covid-19 crisis have resulted in decreased business confidence and recessionary fears, which in turn has led to many investors selling their stocks.
Although this appears to imply that it is a bad time to start investing for beginners, falling markets present extremely good opportunities to acquire undervalued and under-priced assets as others despondently sell. Recent economic struggles are bound to come to an end soon and when they do, equity prices are likely to soar.
Anyone with a long-term investment outlook should strongly consider investing in the stock market as soon as is reasonably possible. The urgency to start investing immediately is due to what is known as the compounding effect. Compounding is the process in which an asset’s earnings, from either capital gains or dividends, are reinvested to generate additional earnings over time. This growth occurs because the investment will generate earnings from both its capital gain and the accumulated earnings (dividends) from preceding periods.
To illustrate how capital gain compounding works, suppose £10,000 is invested into Company A. The first year, the shares rise 10% so that your investment is now worth £11,000. Based on good performance, you hold the stock. In the second year, the shares appreciate another 10%, so that your £11,000 grows to £12,100. Rather than your shares appreciating an additional £1,000 (10%) like they did in the first year, they appreciate an additional £1,100, because the £1,000 you gained in the first year grew by 10% too.
When dividends are added into the mix, the compounding effect is even stronger. Over the long term, reinvested dividends can become increasingly powerful. The FTSE All-Share has grown by 214% over the last 25 years, but with dividends reinvested, this figure trebles to 644%.
#3 Here’s what you need to know about Investing for beginners
Dealing with risk in your portfolio
Before you commit your money, you must set out your investment objectives and understand what your attitude to risk is. Investments which exhibit a high expected return are bound to be riskier than safer stocks that typically earn lower rates of return. It is important to construct unique investment portfolios based on your level of risk aversion and desired investment horizon so that you have the best chance to reach your investment objectives.
It is also crucial to understand that falling markets are an inevitable part of equity investing. Stocks are heavily influenced by the wider economic landscape, which includes the level of inflation, interest rates and other economic data. This means that when the economy is stalling or contracting, the value of your investments may fall. Over the long-term, however, stock markets will generate positive returns. In the last 10 years, the value of the S&P 500 index has risen by 180% – if you had invested £10,000 into the S&P 500 in July 2012, your investment would now be worth £28,000.
#4 The different ways you can Invest
This Investing for Beginners Guide will help you decide whether you want to do it all yourself – or compliment your own investments with those of a fund manager
Stock market investing can be performed actively, by directly investing in shares from personally selected companies, or passively through investment funds.
A stock is a share in the ownership of a company. Each share will represent a claim on the company’s assets and earnings. The price of any given share will rise or fall according to the laws of supply and demand, driven by the perceived attractiveness of the company, its products and services and their subsequent performance. Ownership of a company’s shares gives you the right to receive dividends if and when they are distributed.
Stocks are often defined by their company’s market capitalisation. These can be disaggregated between ‘small-cap’ stocks, referring to companies with a market capitalisation of less than $2 billion, and ‘large-cap’ stock which typically have a market capitalisation in excess of $10 billion. Smaller company shares are generally recognised as offering greater levels of potential capital growth, as profits increase and the share price rises, but also carry increased risk. Blue chip stocks are stocks of a corporation with an international reputation for quality, reliability, and the ability to operate profitably in good and bad times and often fall under the large-cap category.
Investors may also invest in stocks based on whether they are perceived to be growth stocks or value stocks. Growth stocks are shares of companies considered to have the potential to outperform the overall market in the long run due to their future potential, whereas value stocks are classified as companies that are currently trading below what they are really worth (undervalued) and will thus provide a superior return. Growth stocks typically have the potential to perform better when interest rates are falling and company earnings are rising. However, they may also be the first to be punished when the economy is cooling. Value stocks, on the other hand, may do well early in an economic recovery but are typically more likely to lag in a sustained bull market.
Rather than going through the stock selection process, some investors prefer to place their money directly in investment funds, which can be actively or passively managed. Investment funds also come in the form of investment trusts – closed ended funds in which fund managers cannot redeem or create shares.
Passively managed funds stick to a portfolio strategy determined at the outset of the fund, aiming to minimize the ongoing costs of maintaining the portfolio. Many passive funds are index funds. Although passive funds often incur very low fees and are highly transparent, they tend to exhibit lower returns. Exchange Traded Funds (ETFs) are a type of passively managed investment fund that seeks to track the performance of an index, usually a stock market index.
Active fund managers, instead, seek to outperform the market as a whole by selectively holding securities according to a dynamic and ever-changing portfolio strategy. Their investment flexibility is an attractive proposition, but it is important to note that they often have elevated fees and can exhibit higher levels of risk.
The question of which investment fund you should select is based on your own unique investment objectives and level of risk aversion. It is important to do your due diligence on a wide variety of investment funds to make sure you choose the right one that suits your long-term financial needs.
#5 Choosing the right broker
Finding the right broker to suit your investing needs
Choosing the right stockbroker is an essential part of a successful investing for beginners strategy. Your broker will need to provide access to a wide variety of markets, including the ones you wish to trade. Most importantly, your broker should be authorised and regulated by an internationally renowned regulatory body.
Typically, investors will pay a fee to their broker for each transaction they make, whether that’s a purchase or a sale. Fees vary depending on your stockbroker and it’s important to consider how regularly you will trade shares, as each transaction will impact any profits you make from share price growth or dividends. Stockbrokers may also charge annual fees to offset their administrative fees, with some even incurring exit fees when you leave the platform. All in all, fees are a normal part of investing but they should be competitive and not erode any profits unnecessarily.
#6 Leaving investing to the experts?
The experts can offer consistent returns, but fees will reduce profits
Having got this far through in our investing for beginners guide, you should start to feel as though successfully investing in equity markets is something which everyone can achieve, and not something which can only be accomplished by financial experts. Yet, year upon year, financial advisors earn huge sums of money as their services continue to be in very high demand. Although established advisory services have a history of consistent returns, the extra fees incurred when using their services may reduce your profits.
Wealth managers provide advisory services to a wide array of high-net-worth individuals, typically those with a minimum of £100k available for investment capital. It is a discipline which incorporates structuring and planning wealth to assist in growing, preserving, and protecting the wealth of clients.
Robo-advisors, another form of financial advisory, are a class of financial advisor that provide online financial advice and investment management services advice based on mathematical rules or algorithms, with minimal human intervention. They are generally used by investors with smaller levels of investment capital (typically under £100k) or small regular contributions (starting at £10 and typically less than £300 per month)
#7 I want to start investing. How do I get started?
As part of your investing for beginners strategy, set out your objectives first, make a plan and stick to it
Firstly, in order to build your investment portfolio, you’ll need to consider your investing objectives. You should be working to a minimum five year plan. As a starting point, your objectives could be a mix of the following:
- How much can you afford to contribute every month – or do you have a lump sum?
- What returns are you looking to generate? Remember that the higher the returns you aim for, the more risk your portfolio will be exposed to.
- What time frame are you working towards?
- Are you planning to receive income from your investments? Regular dividend paying stocks or funds will be required.
Once you have determined your investment objectives and decided whether you would like to adopt a more active or passive approach, you are ready to begin your journey to become a successful self-directed investor.
As part of this investing for beginners guide, we suggest you avoid allocating all your available funds in a single company, or a number of companies with a similar set of products or services in the same sector – such as finance for example. This will increase the risk to your portfolio. For this reason, adopting a sensible diversification strategy for your portfolio, by investing in a variety of asset classes across multiple geographical regions, will enable you to grow your wealth over the longer term.
If you decide to take a more passive approach and put your money in investment funds, it is important that you do your research on which fund suits your objectives. Websites such as Trustnet and Citywire offer comprehensive fund prices, performance and key facts for the UK-domiciled funds market.
Individual Savings Account (ISAs) are another way in which UK-based investors can begin investing in stocks and shares. An ISA is a tax-free way for UK Residents to save or invest their money through a bank, building society, stockbroker or fund supermarket. The ISA works as a wrapper, where individuals can put a range of different savings or investments inside it, all benefiting from tax-free growth. Types of ISAs include Cash ISAs, Stocks & Shares ISAs, Junior ISAs and Lifetime ISAs.
#8 Maintaining performance of your portfolio
Revisit your portfolio just once or twice a year to rebalance
Once you have started your stock market investment journey, it is crucial to be able to maintain the performance of your portfolio. Over time, asset allocations can change as market performance alters the values of the assets. Portfolio rebalancing, which refers to the process of returning the values of a portfolio’s asset allocations to regain and maintain the original level of asset allocation, is an essential part of maintaining a high degree of diversification and therefore consistent performance levels.
Portfolios should be rebalanced regularly, at least once a year, in order to realign it with your pre-defined investment objectives. It may be tempting to tinker with your asset allocation, especially if a certain asset class or sector is performing well, but resisting this temptation will earn you higher returns and limit your losses over the long term.
Having read our investing for beginners guide, you should now feel as though you are able to start investing in the stock market and construct a long-term portfolio based on your own unique investment objectives. There is no better time than the present to start investing. Make sure you sign up to The Armchair Trader’s daily newsletter for the latest stock picks on UK and international shares, currencies, commodities and other alternative investment ideas.