The six principles of investing everyone should know

James McManus


3 min read

The world of investment management is by no means a piece of cake. It can be complex, and it’s constantly shifting and changing. But there are certain investing principles that will stand any aspirational investor in good stead, whether they have £1,000 or £1m to invest – if they can stick to them.

Owl sitting on post

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 investments 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 (by investing in a diverse range of asset types) can help spread your investment risk and your chances of benefitting 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 twenty years, the UK stock market returned 13.9% per annum (before fees). If you missed the ten best days over that period your return would have been just 7.1% per annum1.

Principle 4: Rebalance, re-invest

Re-balancing is an investment management practice that simply ensures a portfolio stays aligned to its current objectives.

Over time, as the value of each holding in a portfolio rises or falls in value (because of market performance), it will come to represent a larger or smaller proportion of a portfolio.

As a portfolio deviates from its original weightings, the risk of the portfolio changes too. And because higher returning assets tend to be higher risk, over long periods your holdings in higher risk investments are likely to become an ever-greater part of your portfolio, raising your risk above where you started from.

Rebalancing involves buying and selling assets within a portfolio to retain the right proportion – or ‘weighting’ – of different assets in the portfolio, to match your objectives.

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 (such as ETFs) 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.

The typical charge from an active fund is around 0.85% per annum, while the typical ETF charges 0.30% per annum2.

Principle 6: Use your tax-free allowances – ISAs

Individual savings accounts (ISAs) are a flexible tax-efficient way to supplement your investments. You can contribute up to £20,000 this tax year (6th April 2017-5th April 2018) and by using your full allowance every year you can build up a significant portfolio of tax-efficient investments.

There’s no tax to pay on capital gains or income and you can withdraw your capital at any time. However, as investing is for the long-term, we suggest a minimum three-year timeframe.

Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek independent financial advice.

Sources

1. Macrobond, FTSE All Share Total Return GBP, 31st December 1996 – 31st December 2016

2. Morningstar, all IA sector funds primary share classes as at July 2017; and Bloomberg, all LSE listed ETFs June 2017. Calculations on an asset-weighted basis.

 

James McManus

James McManus

A self-confessed ETF geek, James is an investment manager at Nutmeg. He joined in 2015 from Coutts & Co, where he was an associate director in the investment office. James holds a Bsc (Hons) in International Business from Nottingham Business School.

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