Disclaimer: To be clear I’m not an expert or a financial advisor. Anything I say should not be taken as financial advice. This is my own personal experience of investing in the UK.

Mr Money-Side Up

There are some intelligent people out there who can understand really complex information. However, when it comes to investing their brain goes into a mental lock and refuses to understand. Maybe it’s because investing information out there is purposefully complicated or maybe no one has taken the time to really simplify it to its core components.

I can understand that investing is not always going to be a topic that is interesting for everyone. However, I do feel like it’s a topic that IS IMPORTANT FOR EVERYONE.

The Greatest Financial Risk

One of the great financial risks we ignore is the loss of purchasing power over time. With inflation averaging at around 3% a year each year, the money you keep in cash or a low-interest savings account, causes you to lose purchasing power. It doesn’t matter how many units of currency you have. The name of the game is purchasing power.

This is why investing is critical and why I wanted to write this article, to cover just 5 key steps to understanding investing without having a meltdown. I have tried to base this on questions that colleagues and friends have asked me, so hopefully, the Q&As will also be useful for you.

1. How Can I Invest?

The simplest form of investing that I know of is index investing. This is a passive form of investing, where you invest in a portfolio of stocks and shares or an amalgamation of index funds.

An Index fund is constructed to match or track something like the S&P 500. This measures the stock performance of 500 large companies listed on stock exchanges in the United States.

Many investment companies such as Vanguard or Fidelity have these in a section on their website or a selection of all funds which you can filter to search for index funds specifically.

With a fund like this, it’s easy to invest in thousands of stocks. Rather than buy individual stocks, which can be rather like looking for a needle in a haystack, this strategy simply allows you to buy the whole haystack. No complex investing strategies or understanding of investing terms such as P/E ratio required.

“Don’t look for the needle in the haystack. Just buy the haystack”.

John C. Bogle

For example, the Vanguard FTSE Global All Cap Index Fund – Accumulation invests in over 6,402 stocks, across more than 30 countries, and 10 industries (i.e. Financials, Technology, Consumer Goods).

These funds may be called various names, most commonly EFT or Mutual funds. However, regardless of the name or the clever talk around a fund I will always look for something, low cost, geographically diverse, and index-based.

1.2 Why investing in shares could be crucial to your long-term savings success

The average return for the S&P 500 index since 1926 is 9.8%. However, let’s diversify a little and look at the UK stock market from 1800 to 2018. The average return was 5.7%. Between 1850 and 2018 it peaked and troughed between 2% and 9% after inflation.

2. Should I be worried about losing money in the stock market?

The short answer is yes. However, it is entirely possible to follow a responsible investment strategy and generate some serious returns.

People generally lose money in the stock market when they try to time the market or panic sell during market corrections or bear markets.

This naturally happens frequently and are just part of the business cycle. For example, the stock market usually falls by 10% at least once every year.

On the other hand, if you follow a long-term investing strategy then you can essentially sail through these volatile periods. Historically the stock market has always trended upwards, so if you bide your time, your portfolio most likely will too.

Similar to the natural phenomenon of evolution, companies are constantly outcompeting one another for growth over the long-term winning the fight for profit and growth. Those that lose the arms race drop out of the indexes to be replaced by a new species. Simply put, an index is self-cleansing.

S&P 500 Returns
S&P 500 performance (1926 – 2018) – source: macrotrends.net

The concept that the stock market always goes up, is comparable to why money is always worth less over time because of inflation and depreciation. For example, why the cost of a Freddo chocolate bar is no longer 10p.

This is due to factors such as; population growth, increasing productivity, technological and efficiency improvements. As this increases the stock market increases and the absolute value of a currency decreases.

Yearly rise and fall in the S&P 500 (1926 to 2018) – source: macrotrends.net

3. How Long Should I Invest For?

This brings me to a very common question that I have been asked numerous times. “How long should I invest for? Can I withdraw in 5 years?”.

If 5 years is your time horizon then stop reading right now, stocks and shares are probably not for you. Your changes of a positive return year to year are pretty dicey.

US Stock market annualised returns distribution – source: macrotrends.net

However, when you look over a 15-20 year period, the probability of losing money in the stock market significantly reduces. As you can see in the below infographic.

Looking at just one-year intervals, there would be a significant chance of losing money if you invested for this time period. It’s like placing a bet, you could either have gained 52% or lost 37%. Although the average still worked out at a remarkable 8.4%.

5 Year Investing

Over 5 year time frames, these figures become slightly more mild, with the chance you would gain 28.5% or lose 11.7% in any given year, with the average return being 7.1%.

10 Year Investing

Over 10 years, the figures begin to shift in the investor’s favour, with the upper limit rising to 17.6%, with a potential loss of 4.1%.

20 Year Investing

By the time you get to the 20 year windows, there isn’t a single instance in which the market had a negative return. With the upper limit 13.2% and the lowest return of 0.5% (Average 6.7%).

Dividend Reinvesting

The above returns are before taking into consideration the reinvestment of annual returns or compound interest. For example, reinvesting dividends from the FTSE 100 index between 1999 and 2017 this would have given you a total return of 119.3% vs the 20.4% without reinvesting the returns each year.

Staying invested also gives you the best chance of increasing your returns, by contrast trying to time the market could cost you money. For example, missing the 10 best days of the FTSE All-Share index between 1986 and 2016 would have halved your returns.

To find a fund that will reinvest your earnings, simply look for the word ‘accumulating’ at the end of the fund name, rather than say ‘income’.

3.2 Why Are Some Accounts Classified As ‘High Risk’?

This is essentially the investment companies accounting for the volatility that we have just covered in the above section. This is risk over a certain period of time.

However, as we have covered the risk drastically reduces as the time horizon reduces.I should probably state for the record that historical statistics cannot predict future returns. This last part is down to logical assumptions.

4. Do I Need To Invest A Big Lump Sum?

Investing does not need to be expensive. You do not need £100,000 to buy into a fund, or even a £1,000. Although I have come across funds which do require a significant initial investment. There are also funds such as Fidelity Index US Fund P Accumulation, which require as little as £25 to get started.

In my opinion, this can really help with gaining confidence with investing, as you can drop lump sums of increasing size as you gain more knowledge. Yes, you can invest a lump sum whenever you please.

4.2. Can I Set Up A Direct Debit?

You can also set up a direct debit of say £25 a month also, which is amendable to an annual, quarterly or monthly basis with a value of your choosing. As long as it’s above the £25 a month minimum. You can freeze this or defer this payment, or change the fund type if you decide to change your asset allocation.

5. Can I Withdraw The Money?

You can also sell a monetary amount or a percentage of your portfolio at any time. This will equate to a cash value depending on the number of units and the fund price at the time you decide to sell. You can transfer this value to another fund or simply withdraw the cash. However, there are two things to take into consideration:

1. Don’t Panic Sell

If the market is going through a down period such as a bear market or a recession then you should not sell down your portfolio. Most people lose money in the stock market for this reason. Trying to time and dance in and out of the stock market will most likely result in your buying high and selling low.

You must have the discipline and enough income or a cash buffer to cover the down periods. As you can see below, remaining invested through bear markets or even investing, can result in significant benefit when the market recovers.

2. Consider Your Long-Term Goals

When I approach investing, my aim is to never withdraw from the account, until I reach my Financial Independence number. In which case I will withdraw at a safe rate, so the portfolio replenishes itself and does not decline in value.

Final Thoughts On Investing

Investing is a concept that seems so incredibly complicated. Especially when you start considering risk and you think back to recessions and bear markets that we have been through. There is so much terminology out there and misinformation, which in my opinion doesn’t really apply to everyday people, who are not hedge fund manager or day traders.

There is so much information and terminology that I could have covered in this post. However, I wanted to strip investing down the basics that I wish someone would have told me. Mainly that I can invest in index funds and that I don’t need to be fearful of the stock market.

The Stock Market Is Like The Weather In England

The market runs in cycles and just like the weather and seasons in England, the stock market is temperamental and at some point in time winter comes round. However, just like the weather, you don’t sell your house when it rains. Just like the seasons in a year, you don’t have to flee the country every November. Instead you play the long game and wait patiently for spring to come back around.

My Family Told Me Investing Is Risky

My family in the past have explained investing as risky, and after the recession told me, in a moderately emotional tone, the money they had put away for me wasn’t worth what it once was. In reality, it was worth the same amount just it’s valuation at that point in time was lower.

Buying Bonds As An Investment Strategy

For the above reason, I once thought the safe thing was to invest in a ‘bond’ and wait 5-10 years for it to reach maturity. I now know this is not entirely true. You can have complete control over your money, how much you invest and how much you withdraw and when.

Most of all, I wish someone had explained to me in simple terms, how the stock market actually works, how you invest and what I should Invest in. I hope this post has done just that.

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    Further Reading On Investing

    If you would like to read in more detail about investing, then try out one of my previous posts: Where To Start In The Scary World Of Invest – Simple First Steps To Get Started.

    However, maybe I haven’t done a good enough job of convincing you that anyone can invest, in which case check out my post: 5 Reasons Anyone Can Invest With Less Than £100.

    Breaking down investing to it’s core components for the everyday person is really something I want to do more of going forward. So if I have left any questions you have unanswered. Leave them in the comments below, and i’ll get back to you and include them in the next blog post on this topic.