Capital at Risk: All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.
When working out how much you can afford to invest, it pays to heed your grandparents’ advice and play it safe.
When it comes to understanding the basics of saving, budgeting and investing, we should think back to the advice our grandparents gave us. They told us to prepare for a rainy day, start saving as soon as you get that first job, and look before you leap. Society may have changed over the years, but the basics of saving and investing have not.
For anyone investing for the first time, financial advisers usually recommend you build up an emergency cash buffer of at least three months’ salary. This will act as a safety net if you become ill or are made redundant. It also ensures you won’t be thrown off course by a curveball, such as the boiler breaking down or your car failing its MOT.
Once you have that emergency pot put aside in a savings or current account, you can decide how much you can afford to invest. The common misconception is that you need to save thousands of pounds before you make that first foray into the markets, but there are pitfalls with this approach. If you’ve worked hard to save £5,000 and invest it as a lump sum, and then the market tanks the next day, it could dent your confidence and you may sell everything in a panic. Then you will almost certainly end up with less than you invested in the first place.
Once you’ve decided how much disposable income you’d like to invest, it makes good sense to drip-feed money regularly into your investments via direct debit. There are many online investment platforms that will allow you to invest as little as £1. Over time, you could build up a substantial investment without even realising it.
Having finalised your budget, you’ll need to decide which asset classes to invest in. The longer you can afford to part with your money, the more you can afford to invest in riskier assets like equities and commodities. This is because these markets tend to be more volatile in the short term and usually only deliver returns in the longer term. If you’ve set a short-term goal, however, you should opt for a lower risk profile and consider investing in safer government bonds.
The golden rule of investing is to be diversified, which means spreading your money between lots of different stocks and bonds. Diversification lowers your overall risk because if some securities dip, these falls should hopefully be covered by the performance of the other investments, and this would then balance out your return.
Risk: Diversification and asset allocation may not fully protect you from market risk.
If you opt for an Individual Savings Account (ISA), any interest, income and capital gains you make will be tax free. Another option is a General Investment Account, which has no limit on how much you invest, although it doesn’t offer the same tax benefits. It’s also worth checking how much online trading platforms and fund managers charge you to trade; their fees will vary, and this could affect how much you see in overall returns.
You will also need to be patient. The markets will shift up and down every day, but experienced investors know they will have to wait years to accumulate wealth steadily and securely. They also know that they won’t benefit from long-term market gains if they invest in January and then sell their holdings to buy Christmas presents later in the year. If you’re after instant gratification, you should think twice about investing in stocks and shares because of their short-term volatility.
A diversified long-term strategy gives your investments the best chance of appreciating in value, and you can also benefit from compound growth. This is where you may be able to earn interest on your original capital and also on the interest. As your investments grow, this compounding affect can have a significant impact on the value of your portfolio.
No investing is completely without risk, even if you follow your grandparents’ advice, but investing sensibly and keeping your goals and timeframe front and centre will mean you’re much more likely to be an investor for life.
Checklist for how much you can afford to invest:
- Think about your goals and how you plan to get there
- Calculate your income and outgoings to start a basic budget
- Build up an emergency cash buffer of at least three months’ salary
- Work out how much you could part with on a regular basis
- Shop around for the best online trading platforms
- Make sure you invest in a diversified portfolio
- Try to make regular payments into your investments
