Your money grows in 2 ways, you spend your time working for money or you get your hard earned money working for you. The limitations on the first option are obvious, you only have so many hours in the day. The opportunities on the second one are only limited by your imagination. Your imagination could come up with countless ways of building wealth, but before even going that route, there is a simpler method – investing in the stock market.
Why should I invest my money in the stock market?
Savings are great but the truth of the matter is the return on savings is not going to get you to your goals. The return on a bank savings account currently is between 0.2% to 1.50%, the average inflation rate is 2%. This means that every day that your money sits in the bank account it becomes worth a little less.
A historical journey over the performance of the UK Stock exchange by looking at the FTSE All share Index shows that the market has returned an average yearly rate of 10.44% over the last 34 years. A much better option for reaching your money goals.
I can see what the UK Stock Exchange has done but what does that mean for me?
What the graph above is telling you is that is you were invested in every company on the UK All Share index (around 641 companies representing 98% of listed shares in the UK) you would have earned an average yearly rate of 10.44% on your investment. Your earnings would have come from dividends paid on those companies that you would have reinvested, as well as capital gains from increases in the value of your shares.
Ok, I’m starting to get convinced but doesn’t investing in the stock market mean I have to be able to select which companies to invest in or is there a simpler approach?
There are absolutely simpler approaches then trawling through the financial press to decide which companies to invest in. You don’t have to be an investment guru to start building wealth. Although the financial community is still filled with jargon, many providers have realised the gap in the market for simple, transparent investment vehicles and new options are coming onto the market every day. The choices can become a little overwhelming but the following key considerations should start to narrow the field:
- Look for low cost options. High costs eat away at your investment returns and that 10.44% average return starts to look a lot smaller when you are paying away a huge chunk.
- Make sure it is diversified. While shares have provided excellent returns over long periods, they are subject to a huge amount of fluctuation upwards and downwards. To reduce some of that volatility and maximise your chances of a long term positive result you should have some lower risk assets as well that respond differently than shares do to economic factors. For example, bonds, basically a loan you make to a company or a Government for a given return, provide a lower return but are generally less volatile than shares.
- It is suitable for the level of risk you want to take. This is all about knowing your tolerance for watching your investment possibly drop by 50% over an extended period. (The FTSE 100, the index of the 100 largest listed companies in the UK dropped by 50.44% from December 1999 to March 2003 and by 47.82% during the financial crisis). If you know this would give you sleepless nights, you are definitely not alone. Mitigate this risk by choosing the portfolio that is more suited to what you can stomach. This may mean a lower return but may be a small price to pay for peace of mind.
- It is simple. The approach you take should be understandable, transparent and easy to do.
I get all that, so how do I get started?
There are 3 easy routes to start-in
The first on the easy scale are Robo-advisors. These are online investment managers who provide minimal human intervention in the investment activity. After inputting your goal, your investing timeline and risk tolerance the Robo-advisor selects a ready-made portfolio for you. The advantage? This is a low cost, simple approach to getting a diversified portfolio with a low minimal investment, in some cases as low as £100. The disadvantage, there is a very narrow range of portfolio options to choose from, but that can be an advantage in itself for ease and simplicity.
The second option is to register on a platform such as Charles Schwab, Fidelity, Vanguard or Hargreaves Lansdown to name a few, and select one of their ready-made low cost life style portfolio’s. These are selected in a similar fashion to the Robo-Advisors but offer a much wider range. The disadvantage to these is a slighter higher initial minimum investment of around £500 upwards is required.
The third option, create your own portfolio on an investment platform from low cost index tracker funds. It does involve a little more hands-on selection, however you will still be able to keep the costs down and get the diversification you require through the variety of funds you select. This can be done with a minimum investment of £100 per tracker fund selected. Ideally you would want your tracker funds to reference shares and bonds with some geographic and sector dispersion.
Select your approach, establish a monthly debit order for an amount that you can comfortably invest. Leave the investment and let the magic begin.
Let me think about it.
Yes, take some time to research the different options, get an understanding and find what suits you. But if you are still hesitant to get started consider this.
In scenario 1, At 25 years old you start investing £100 per month earning a 10% return, you invest for 10 years, stop contributing and leave it invested for 30 years.
In scenario 2, you start investing at 35 years old, also investing £100 per month earning a 10% return, you invest for 30 years.
It is clear, your time in the market counts, the longer you are in, the larger your investment can grow.