5 concepts to boost your investing knowledge
The UK population is reluctant to invest and holds too much cash, according to the Financial Conduct Authority (FCA). Nearly two-thirds of UK adults with £10,000 in investable assets are concentrating 75% of these in cash, rather than equities and bonds.
This is partly explained by widespread misunderstanding about investing. To many British people, it feels intimidating and confusing, with 50% saying they don’t understand the jargon. Fortunately, investing does not need to feel this way.
Our team of financial advisers want to do their part to help correct this. In this article, we offer five investing concepts that every investor should know – explaining everything in simple terms so you can build wealth with greater clarity and confidence.
#1 Asset class & allocation
An “asset” is something that is valuable to you, now or in the future. Cash is a clear example. It grants you the ability to buy goods (e.g. food), and you can exchange it to buy other assets quickly – e.g. shares in a company.
This highlights something important – there are many types of assets (not just cash). In financial planning, we group assets based on shared characteristics, behaviours and past market performance. The main ones are: cash, equities, fixed-income securities and property.
Yet, which assets are the best to acquire? Should you concentrate on one asset (e.g. cash), or divide your wealth across many asset classes? These questions all circle around the matter of asset allocation.
How you allocate assets will depend on many factors, such as your specific financial situation, goals, values and time horizon (i.e. the amount of time until you need the money). A financial adviser can help you decide on the ideal asset allocation based on your unique investor profile.
#2 Diversification
Let’s do a thought experiment. Suppose you move overseas to take a job in Thailand. You save some of your salary each month, putting the Baht into a local account.
However, when you look to move back to the UK after years of saving, the currency plummets against the pound (GBP). The money you thought you would take back to the UK is halved.
Now, imagine a different scenario. Instead of keeping savings in Baht for years, you regularly convert them to other currencies (e.g. GBP, USD) and keep the funds in multiple secure accounts. Here, you are “diversifying” your currency risk. If the Baht falls, your total cash savings will not be hurt as badly (assuming the other currencies hold/appreciate in value).
This principle is also applied to investing. If you invest in shares, for instance, financial advisers recommend you “spread out” across multiple companies, funds, markets and geographies. This avoids putting all your eggs in one basket.
#3 Pound-cost averaging
Imagine you suddenly receive a large amount of cash (e.g. from an inheritance) and you want to invest it. Should you do so all at once, as a lump sum? Or, should you “drip-feed” it steadily into various investments?
The latter approach is called pound-cost averaging, and this is the standard way people invest into their pensions – i.e. a percentage of a worker’s salary is put into their pension each month, which goes into funds offered by their pension provider.
Pound-cost averaging can be less stressful than lump-sum investing. If you invest a lump sum and the market suddenly plummets, this can quickly lead to investor panic. By taking a gradual approach, however, you can smooth out the highs and lows (volatility) of the market.
#4 Compound interest
Investing can benefit from a “snowball effect” depending on the amount of time you keep your funds invested. This is called compound interest, and it can have a powerful effect on wealth building, especially over 20, 30 or 40 years.
For instance, suppose you invest a £10,000 lump sum and your investments grow by 7% per year. Over ten years, the portfolio could stand at almost £20,000 (gaining almost £10,000 in interest). However, what about longer time horizons?
Over twenty years, the portfolio could hold almost £40,000 (almost £30,000 gained in interest). Over forty years, almost £150,000 could be contained in the portfolio – i.e. almost £140,000 in interest.
Why it matters? The longer your money is invested, the more powerful compounding becomes.
#5 Funds and ETFs
Imagine you want to invest in a big company, like Apple. Right now, one Apple share is worth over $200. That could be too expensive for many investors. Many other stock prices are far higher than this. So, how can you truly “spread out” your investments in this situation?
This is where funds can truly make a difference. Think of them like “baskets” of investments, where you pool your funds with other investors.
For instance, rather than buying one company’s stock directly (e.g. Apple), you buy a share in the fund, which, itself, invests in dozens of stocks using the investors’ money.
An ETF (exchange-traded fund) trades on a stock exchange, just like company shares. You can buy or sell them throughout the day. These funds can come in two main forms:
- “Passive” funds follow a market index, such as the FTSE 100 (the UK’s leading index, representing the value of our 100 largest companies).
- “Active” funds are professionally managed – i.e. a fund manager actively selects and manages the investments to try and beat the market or outperform a specific benchmark (like the FTSE 100 or S&P 500).
Invitation
We hope this article has given you greater clarity and insight into the world of investing.
If you’d like to make sure you’re taking the right steps to safeguard your financial future and build your wealth, please get in touch.
Your capital is at risk. Investments can go down as well as up. Past performance is not indicative of future results. Tax treatment depends on individual circumstances and may change. Content is for information only and does not constitute investment advice. Any decision to invest is the reader’s own. Diversification is key to managing risk.
