1st July 2016

What you need to know to become a more confident investor

Before you choose or make any investment decisions, you need to know that investing involves the possibility of loss. These key considerations help you become more confident about your investment decisions.

Review your needs and goals

It’s well worth taking the time to think about what you really want from your investments. Knowing yourself, your needs and goals and your appetite for risk is a good start.

Consider how long you can invest

Think about how soon you need to get your money back. Time frames vary for different goals and will affect the type of risks you can take on.

For example, if you’re saving for a house deposit and hoping to buy in a couple of years, investments such as shares or funds will not be suitable because their value goes up or down. Keep to cash savings accounts like Cash Individual Savings Accounts (ISAs).

If you’re saving for your pension in 25 years’ time, you can ignore short-term falls in the value of your investments and focus on the long term. Over the long term, investments other than cash savings accounts tend to give you a better chance of beating inflation and reaching your pension goal.

Make an investment plan

Once you’re clear on your needs and goals – and have assessed how much risk you can take – you need to obtain professional advice to identify the
types of product that could be suitable for you.

A good rule of thumb is to start with low-risk investments such as Cash ISAs. Then, add medium-risk investments like unit trusts if you’re happy to accept higher volatility. Only consider higher-risk investments once you’ve built up low- and medium-risk investments. Even then, only do so if you are willing to accept the risk of losing the money you put into them.

Diversifying to accept more risk

It’s an accepted rule of investing that to improve your chance of a better return, you have to accept more risk. But you can manage and improve the balance between risk and return by spreading your money across different investment types and sectors whose prices don’t necessarily move in the same direction. This helps you to smooth out the returns while still achieving growth and reduce the overall risk in your portfolio.

Decide how hands-on to be

If you need help understanding a financial product, it’s essential that you obtain professional financial advice before you proceed.

Investing can take up as much or as little of your time as you’d like. So if you want to be hands-on and enjoy making investment decisions, you might want to consider buying individual shares – but make sure you understand the risks.

If you don’t have the time or inclination to be hands-on – or if you only have a small amount of money to invest – then a popular choice is investment funds, such as unit trusts and Open Ended Investment Companies (OEICs). With these, your money is pooled with that of lots of other investors and used to buy a wide spread of investments.

If you’re unsure about the types of investment you need, or which investment funds to choose, seek professional financial advice.

Higher-risk products have their place

There’s no reason not to invest in higher-risk products if they suit your financial goals and attitude to risk and you already have a safety margin in low-risk investments such as a Cash ISA. But only consider higher-risk products once you’ve built up sufficient money in low- and medium-risk investments. Before investing, it’s essential that you fully understand their specific risks and are happy to take them on.

Review investments periodically

Investors who watch their investments day to day could have a tendency to buy and sell too often and subsequently achieve poorer returns than investors who leave their money to grow for the long term.

Annual reviews will ensure that you keep track of how your investments are performing and adjust your savings as necessary to reach your goal. You will get regular statements to help you do this.

However, don’t be tempted to act every time prices move in an unexpected direction. Markets rise and fall all the time, and if you are a long-term investor you can just ride out these fluctuations.

Different ‘styles’ of investing

Some assets are said to be ‘negatively correlated’, for instance, bonds and property often behave in a contrarian way to equities by offering lower but less volatile returns. This provides a ‘safety net’ by diversifying many of the risks associated with reliance upon one particular asset. It is also important to diversify across different ‘styles’ of investing, such as growth or value investing, as well as across different sizes of companies, different sectors and different geographic regions.

Growth stocks are held as investors believe their value is likely to grow significantly over the long term, whereas value shares are held because they are regarded as being cheaper than the intrinsic worth of the companies in which they represent a stake. By mixing styles that can out- or under-perform under different economic conditions, the overall risk rating of the investment portfolio is reduced. Choosing the right combination of these depends on your risk profile, so it’s essential to seek professional advice to ensure that your investment portfolio is commensurate with your attitude to investment risk.

Currency risk

You should also be aware of currency risk. Currencies (for example, sterling, euros, dollars and yen) move in relation to one another. If you are putting your money into investments in another country, then their value will move up and down in line with currency changes as well as the normal share price movements.