Guide: Investing for Beginners

Stock markets around the world have suffered from extreme volatility over the last few years as conflicts, 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. 

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. Historically, economic struggles are cyclical and eventually rescind. When they do, equity prices are generally expected 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%.

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.

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)