The world of savings and investment management is by no means a piece of cake. It’s a complex organism that is constantly shifting and growing. But there are certain key principles that will stand any aspirational investor in decent shape, whether they have £50k to invest or £1m to invest – if they can stick to them.
Principle 1: Remember the trade off between risk and return
Understanding risk and return is crucial to sound, sensible investing. That doesn’t mean you should take a low or high risk and return strategy; it’s all about settling on the level of risk you’re comfortable with. Different types of injvestments tend to have different levels of risk associated with them. Stocks can be more high risk than bonds, for example. And emerging market stocks can be more high risk than developed market stocks. But the higher the risk, you’ll often find there’s also a greater potential for higher return on your investment.
Principle 2: Be diversified
Making sure you don’t have all your eggs in one basket can help spread your investment risk and your chances of beneffting from potential investment returns.
Principle 3: Invest for the long term
Jumping in and out of the market can lead to missed opportunities. Over the past 10 years the UK stock market returned 9.9% per annum (before fees). If you missed the 10 best days over that period your return would have been just 3.5%.
Re-balancing is an investment management practice that simply ensures a portfolio stays aligned to its current objectives. Below is an ISA savings example that neatly demonstrates the power of regular re-balancing and re-investing in order to keep your wealth management goals on track.
In this example we assume a contribution of the maximum amount on the first date of each tax year. The money is then invested in a corporate bond and equity fund each year to ensure the split is always 50/50 – this is what we call ‘re-balancing’. As you can see, contributions of £102,880 would now be worth around £166,200. Without rebalancing the value would be £162,900. (Assumes funds deliver the market return, less costs of 0.2% and 0.3% pa per fund respectively. Based on data fro FTSE All-Share and Merrill Lynch Sterling Non-Gilts total return indices).
Principle 5: Keep costs in line with your investment approach
Investment can be active or passive. Active funds try to beat the market while passive funds aim to deliver the market return. You’re much less likely to find an active manager that outperforms the market than one who underperforms it. And when you take into account funds which didn’t survive the five-year period this is even less likely.
The typical charge from an active fund is around 1.5-2% per annum. The typical charge from a passive find is 0.1-0.7% per annum.
Principle 6: Use your tax-free allowances – ISAs
ISAs are a flexible tax-efficient way to supplement your savings. You can shelter up to £11,520 this tax year (2013/14) and by using your full allowance every year you can build up a significant portfolio of tax-free investments. There’s no tax to pay on capital gains or income and you can withdraw your capital at any time. (Note that equity dividends are taxed at 10% with no further tax to pay and income from other assets is tax free. Once capital is withdrawn, investment back into an ISA is subject to the annual limit).
As with all investing, your capital is at risk.. Past performance is not an indicator of future results, and future returns are not guaranteed.