A Beginner’s Guide to Investing
In this article, guest contributor Andy demystifies ‘investing’, explaining what it means, common types of investments, the benefits and risks, and how to make a start.
Photo by M.B.M on Unsplash
After putting aside money for savings and an emergency fund, we often hear how we should invest the rest, but what exactly does this mean? If you’re just starting out, don’t have significant capital, and aren’t a financial guru, what exactly are you supposed to do?
It can get pretty confusing, but you’re on the right track because reading articles like these is key to good investing. Researching and knowing what you’re getting into will serve you well throughout your financial journey.
What is investing?
Investing means setting some money aside and making it work for you, by generating passive income (i.e. you don’t need to do a lot of ‘active’ work to receive returns). A relatable and easy-to-understand example is stock trading. By purchasing stocks of companies that have gone public, through a broker, you earn money when the stock price goes up and lose money when the stock price dips.
You invest in something with the aim of generating an income, or profit – because you believe it will increase in value over time. It’s important to note, however, that investing comes with risks.
The value of an investment can go down as well as up.
You could get back less than you put in.
Unlike the security of savings where your money will earn you a guaranteed rate of interest, with investing, there are no such guarantees of returns. It might earn you substantial rewards, but equally, you could lose all the money you invested by making the wrong decisions. It is therefore recommended that you never invest any money that you can’t afford to lose. You could also consider consulting a financial advisor.
If you decide to go ahead, you should generally be prepared to invest your money for at least five years, to smooth out the effects of any fluctuations in the market.
What can you invest in?
Almost anything! The most common types of investments are stocks and shares, bonds, funds and property. More specialist options include cryptocurrencies and collectibles like art, antiques, wine, cars etc.
Common investment instruments
Depending on your investment plan and familiarity with the financial industry, there are many investment instruments that you can choose from. In this section, we’ll explain some of the most common ones.
You can own parts of publicly traded companies by buying shares of stocks, or equities from a broker.
Stocks, shares, equity – what’s the difference?
These terms are often used interchangeably and can be confusing, but here’s a basic explanation:
‘Stocks’ is the generic term for owning a slice of multiple companies e.g. you could own stock in Barclays, BP and British Airways.
‘Shares’ refers to owning units of a specific company e.g. you could own 20 Barclays shares. You would be a ‘shareholder’.
‘Equity’ describes the total amount of stock owned by a shareholder. E.g. if a company had 1000 shares and you owned 20, you would hold a 2% equity stake in that company.
As a shareholder, the value of your investment will go up and down with the share price. If a company is doing well (or is expected to), demand for its shares will usually increase, pushing up its share price. Conversely, if the company is performing badly (or is expected to), its share price is likely to fall. (Other economic factors can also influence share prices).
The two most common ways you can earn money through stocks are when stock prices rise and when companies pay out dividends.
Dividends are funds that the company has earned and shares with its shareholders. This can be given out as cash or in the form of additional stocks. However, bear in mind not all companies issue dividends to their investors. If you’re looking to earn an income through dividends, check if that particular company is in the habit of passing on its earnings to shareholders.
Bonds are essentially loans to credible institutions like large corporations and governments. Because bonds tend to be issued by more established bodies, they are generally considered more conservative investments. Many investors and financial institutions consider treasury bonds (i.e. bonds issued by governments) to be risk-free.
Bonds are fixed-income instruments, which means that investors are given a specific maturity date and a fixed rate of return for their investments. The maturity date of bonds ranges from less than a year to 10 years or even longer.
Funds are a ready-made portfolio of investments. You’re buying into a mix of assets (e.g. shares, government bonds and property), which can help spread the risk. Over a certain period of time, some of the fund’s investments may perform badly but others might do well.
Mutual funds are a blessing for new investors because, unlike the other instruments we’ve mentioned so far, they employ a professional fund manager who makes the strategic investments for you.
A mutual fund pools the money collected from several investors, then the fund manager invests in various securities like stocks, bonds and other assets, and monitors their performance on your behalf. Units of mutual funds are sold as net asset value per share (NAVPU). Similar to stocks, you earn when the NAVPU increases and lose money when it goes down.
If you’re interested in the stock market but don’t have adequate knowledge about individual companies, you can buy shares of index funds from brokers.
An index fund simply follows the movement of a specific industry or sector. If, for example, you were to participate in the London-based FTSE 100 (Financial Times Stock Exchange 100) Index, you would be banking on the top 100 companies listed on the London Stock Exchange.
An Index fund is another beginner-friendly option because it’s easy to track the fund’s performance, it offers diversification which spreads your risk, and charges relatively low fees (from .05% annually). However, there are countless index funds, so while monitoring a fund is easy, you’ll still have to do research on which fund is best aligned with your investment goals and strategy.
Similar to index funds, Exchange-Traded Funds (ETF) are based on the performance of an index. The key difference between them is that ETFs are traded like stocks whose values fluctuate throughout the day, whereas index funds are only priced at the end of the trading day. If you’re looking for more control over the price at which you buy or sell, ETFs offer you this advantage.
Unlike mutual funds, the fees charged by ETFs and index funds are generally cheaper, since there is no active involvement from a fund manager.
3 Steps for Sound Investing
1. Create an investment plan
Your investment plan should take into consideration your investment objectives, how long you can afford to keep your funds invested, what returns are acceptable, and your risk appetite or how much you’re willing to lose before turning a profit.
2. Research instruments that match your goals and chosen investment strategy
Once you have an investment plan in place, it will be much easier to look for investments that match your risk appetite, investment horizon, etc. Learn as much as you can about potential investments prior to any transaction, to avoid unpleasant surprises in the future.
3. Monitor your investment
The more volatile your investment and the shorter your investment timeline, the more frequently you’ll need to check on it. Monitoring your investment will allow you to gauge if it is progressing according to your expected performance, or if you need to cut your losses.
Tip for beginner investors – start early
Long-term investments allow many beginners to weather short-term price fluctuations and take advantage of long-term and compound growth. The best way to open yourself up to this possibility is by starting your investment journey as early as possible and being consistent in your trading decisions.
Find out more:
Investing for beginners – Money Saving Expert
10 key need to knows to get you started
When to save or invest
How to decide what to do first when you have spare cash: pay off debts, add to a pension, invest or save?
Investing for beginners – HSBC
The main types of investments, what you can expect & rules to remember
About the author:
Andy Schmidt has been in the online content world for over 10 years as a freelance copywriter, technical writer and translator, covering different topics – finance, energy and also sustainability. What is he doing when not writing? Andy learned how to enjoy long walks, play chess, and finally – how to sleep at night.
This article is for general information purposes only and does not constitute advice. When making important financial decisions, we recommend that you do your own research, and where necessary, seek independent advice from a qualified professional.