THE BEST GUIDE TO FINANCE AND INVESTMENT FOR YOU
How to Invest Your Money Effectively – No Matter How Much You Have
Investing wisely is the key to a sound financial future. Individuals who can tolerate even a small amount of risk are better off placing their money in investments rather than letting it sit in a checking account with a low interest rate. Whether an investor has £5, £50, or £500 to use, building a portfolio of investments over time will help ensure a comfortable retirement.
Determining risk tolerance is the first step in determining how to invest effectively. An investor’s risk tolerance is based on how much they are willing to risk losing in order to realize a profit. There are three basic investor types, though some investors may fall between types.
- Conservative investors are not willing to take a loss. They usually are approaching retirement, and will typically have almost all of their investments in cash or cash equivalents. Such a portfolio will actually be losing money over time, since it erodes in purchasing power as inflation continues.
- Aggressive investors are willing to risk larger amounts of capital to participate in market increases. They are typically young and can put more capital at risk because they have time to make back any losses.
- Moderate investors are in the middle of the road. They can afford to take risks with their investments and may participate in aggressive investments, but also hold conservative assets in their portfolio.
A balanced approach is known as diversification. Moderate investors are typically well-diversified. Diversification is the best way to protect a portfolio from radical changes in the market, with conservative investments such as cash equivalents balancing out losses from aggressive investments in the stock market.
Once an investor has determined their risk profile, they should focus on building a balanced investment portfolio that represents most major asset categories. This diversification will protect the entire portfolio from being entirely wiped out while realizing gains over the long term. With that in mind, let’s look at how to invest effectively.
If You Have £5: Retirement Accounts
Anyone who is eligible should be contributing at least £5 a week to a pre-tax retirement account, such as Self-Invested Personal Pension (SIPP) or employer pension. Money contributed to these accounts is taken from an individual’s paycheck and invested through a money manager. Since the money deducted is taken on a pre-tax basis, the individual owes less personal income tax from wages. When the money is taken out during the individual’s retirement it is taxed at the rate for the individual’s income bracket at that time. This is recommended for any individual whose tax rate during retirement is likely to be less than their tax rate during their working years.
There are also post-tax retirement accounts, such as Stocks and Shares Individual Saving Accounts (ISAs). An individual contributes to these types of investment accounts with income that has already been taxed. When an individual retires, the money is withdrawn without tax. These accounts are recommended for those who are likely to have a higher income tax rate in their retirement years than they do now.
Retirement accounts typically allow investors to hold most asset classes, although restrictions may be placed by the revenue service or the money manager. Investors can take advantage of the same risk profiles as they would be able to as a private individual with considerable tax benefits.
If You Have £5: Stocks
Shares of stock represent ownership stakes in a business. As the value of a business rises and falls, so does the price of its stock. With companies whose stock can be bought and sold on trading exchanges, that value is more frequently the perceived value, rather than the actual value if the company were to be sold. Investor perceptions can change quickly, which is why the stock market is considered risky.
A brokerage account is required in order to trade stocks as an individual. A fee-per-trade is assessed by the brokerage firm, which varies. Choosing the brokerage with the lowest fees allows investors to invest more money; however, such firms, sometimes called discount brokerages, may offer less investment support. Investors can also use financial advisors, who earn commissions on certain trades or charge investors a straight annual fee for their services.
If You Have £50: Bonds
There are three major bond issuers: corporations, municipalities, and federal governments. These entities offer bonds to raise money, typically through a bond auction. Purchasers of bonds are loaning money to the entity; the entity agrees to pay interest to the purchaser, and then buy back the bond from the purchaser at its face value once the bond reaches maturity. The maturity date of bonds varies, but is usually six months or longer from the issue date. To realize the greatest gains individuals should plan to hold bonds until their stated maturity. Selling before maturity usually means selling for less than face value (selling at a discount).
Bonds offer an income stream in the form of interest, and can also offer tax benefits – particularly municipal bonds. Municipal bonds offer a lower interest rate then other bond types, but in many instances the gains realized from a municipal bond are not federally taxed, and may be tax-exempt locally as well.
If You Have £500: Mutual Funds
Mutual funds are distributed as shares like stocks. Shares purchased represent shares in the mutual fund, and the mutual fund manager uses that income to purchase stocks and bonds to build a portfolio with the goal of realizing gains. Any gains realized are distributed amongst shareholders of the mutual fund. It is a way to diversify risk among many individuals and leverage their combined buying power.
Mutual funds can either be conservative or aggressive, and the fund’s average returns and level of risk will be rated on a sliding scale from high to average to below average. Mutual funds charge investors an annual fee to cover expenses (average is 1.5%) as well as an exit load fee if they sell the fund before the agreed lock-in period ends
By steadily contributing to an investment portfolio in small amounts, investors can build up an impressive net worth. Buying assets at different risk levels and keeping different assets in the portfolio will balance an investor’s exposure to risk, protecting the portfolio’s worth from radical swings in value. Just forgoing a cup of coffee can be the first step to investing effectively.