In the early days of my career it was common to brush shoulders with the briefcase carrying commuters, who read the investment columns in broadsheet papers with a look of intent that matched their symmetrical pocket squares. I often looked at them and assumed they had their lives completely together. It would take me some years to fully understand the difference between working for money, and making your money work for you. Whilst there is a strong business case to invest your money, the reasons why you do so are just as important as the execution. So naturally a good place to start is exploring the purpose.
Why do people invest?
The clever answer is that people invest as a means of building their wealth, for a time not yet lived, to ensure they can meet their financial obligations, and maintain a certain lifestyle. But in simple terms, investing your money requires you to look into the future, set some objectives, then work back to establish how best to fulfil those requirements. The most frequently asked question I receive from social media on this subject is; “Where should i invest my money”. An open ended question that only someone with beneficial interest can answer without hesitation. We mustn’t seek solutions without firstly identifying our need. From my experience, the main reasons why people choose to invest consist of, but not limited to;
- Receiving a better rate of return than they do on their savings.
- Keeping pace with inflation to ensure they maintain the buying power of their money.
- Reach financial goals, I.E buying a house, putting children/grandchildren through education.
- Retirement, so they continue to receive an income when they stop working.
- Because they’ve been told that’s what smart people do!.
Over the years I’ve been amazed by the number of people who relate to point number 5. I can only imagine this comes from the consumption of media & press showcasing the lives of the rich and famous, and authors telling you to buy their books so that you can find all the secret nuggets to investing. Quite frankly it doesn’t matter how you reach the conclusion that you need to invest, there are no prizes for those with the best reason for doing so. Once you’ve established your goals the most important question is how you go about achieving it.
It’s important to understand that not all investments are suitable, and your personal circumstances will dictate the right solution. This is often my biggest concern, when people make financial decisions purely based on the fact that someone they know has profited from doing something similar. If you neglect to consider your needs before investing, then you are complicit in putting your money at more risk than necessary. So here are some things to ask yourself before seeking any solutions, I call it the ‘Readiness Test’;
- Amount -How much money do you have to invest- will it be a lump sum or do you intend to contribute more over time?
- Time horizon- How long can you leave this money before you need it?
- Your Age – For the more senior readers, investing in later life could limit your time horizon
- Structure – What is the most tax efficient way of structuring your investment?
- Risk appetite – What would happen if you lost some or all of the money you’ve invested?
For those with very little or no appetite for risk, then your options are limited to deposit or notice accounts. In this case your money stays in cash, and for an agreed rate of interest you wont wake up in cold sweats should some disaster happen in a particular market over night. You will be covered by the Financial Services Compensation Scheme of up to £85,000 per banking institution. If your objective with the money is to make a financial commitment in the very near future, I.E house deposit, buy a car or a wedding, then i would consider you to be in the low risk category and should seek to protect your capital at all costs. However if the answers to the ‘Readiness Test’ suggests that you have a bit more time and can handle a bit more adventure then read on as we explore the options available.
What type of Investments can I make?
The most common type of investment we hear about is Equities, otherwise known as Stocks and Shares. When you invest in shares, you’re simply purchasing a piece of a company, and if the value of the company grows, so does the share you’ve bought. The idea is that you can someday sell those shares for more than what you acquired them for, and make a profit. On the other hand if the value of the business decreases then the value of your share will also decrease and ultimately you could make a loss.
Shares will typically provide two types of return for the investor, annual income (Dividends) and long-term capital growth. At this point I must stress the importance of having sufficient time horizon to benefit from this type of investment. In most cases its highly unlikely that you will achieve your objectives by putting money into the markets and selling them within 12-24 months. You can hold stocks and shares yourself or as part of a group (fund). Investing in a fund means that you spread the risk with others, but the fund also invests in more than one company so offers diversification. The level of return you’re seeking needs to be in line with the risk you’re prepared to take. If you’re chasing double digit returns but cant afford to experience any dips, then you’re in the wrong game.
What should I consider before Investing in Equities?
You wouldn’t buy something important from a place you’ve never heard of, or give your money to someone you don’t trust, so If you’re considering investing in the stock market, do your research into the companies that you want a piece of. Who runs it, how they’re performing, what are their future plans, how strong is their position in the market/sector. Of course if you have the resources, you can delegate the strategic decision making to an investment manager, a professional who can advise you on where the smart money goes.
For those seeking further adventure still, there are a multitude of options to consider but to name a few there are; Bonds, Mutual Funds, Options, Index funds. When you’re ready to buy your shares you will need to sign up to a ‘Share Dealing’ platform in order to execute your trades. It’s often said that over the long term, Stocks and Shares outperform most other asset classes, and if you look back to 2008, those who entered the market at that point would have easily doubled their money in the 10 years that followed.
There is a perception that all rich individuals hold stocks and shares as part of their overall wealth, and unfortunately that simply isn’t true. I’ve come across a number of people with significant wealth who only acquire physical assets and don’t have the stomach or patience to watch their hard earned money bounce around on a graph. Whether this strategy is better than the previous one discussed, only your individual circumstance can dictate. However it’s true to say that having a diverse personal balance sheet requires more than just one asset class and Real Estate tends to be a regular feature.
These days you can invest in property by buying a fraction of one via online platforms, saving you the need to pay stamp duty, legal costs or find a five/six figure sum for a deposit. Some of these online property investments will pay you a dividend which is the rental income from the property, once all costs and provisions are deducted. The more traditional type of property investments are those wholly owned by individuals either in personal name or in a tax efficient structure like a Special Purpose Vehicle ( SPV). These range from Houses, Flats, Retail Units, Hotels, Commercial offices and even Agricultural land.
For those that want an investment that produces steady income, this tends to provide the answer. You generally know the amount of rent to charge each month, and you have the benefit of reviewing this at a frequency that you choose. You also have the ability to make improvements to the property in hope of achieving a capital gain should you sell it in the future.
On the flip side, there is a less glamorous element to being a landlord and since the tax relief changes were announced some years back, most people I know have reviewed their exposure to this asset class. Contrary to some beliefs, it doesn’t take much to adversely impact the profitability of a buy to Let portfolio. Considering upkeep, management costs, mortgages payments and tax, there are several expenses to account for. Not to mention potential void periods, where tenants leave or simply cant pay as we’ve seen during the Covid-19 pandemic. Picking the right property from the start is a strategic move that shouldn’t be overlooked, it can and will save you time and money down the line.
What are some alternative investments?
Whilst Cash, Equities and Property are the most common items on a wealth balance sheet, there are also commodities ( Gold, Silver, oil) and increasingly passion assets. These don’t tend to produce income but can fetch eye watering prices if you’re fortunate enough to have something rare that people want. There are several Wealth Managers who over the last decade have tracked and written about such assets and they include things like; Handbags, Watches, Classic cars, Art, Rare instruments, Wine ,Whisky and even Stamps.
The resale market for these items are not as big as Properties or Equities, but their values will be impacted by economic sentiment nonetheless. So it helps to know if what you’re buying is a good find. For those seeking even quirkier types of investments you have the likes of Peer to Peer lending, Crowd Funding, EIS, SEIS, Angel Investing (Dragons Den without the cameras).
The most important principle in all of the above is good cash management. Too often I see unrealistic expectations where the initial capital deployed is insufficient to achieve the goals or targets set, therefore people choose the highest risk by default in hope to be the ‘lucky’ ones that get all the uplift and none of the downside. As a friend said to me recently, the moment your money becomes invested, you develop a sudden interest for economics, as you clearly see all the factors beyond your control that could make or lose you money.
Taking all the above into consideration, the smart money goes where the smart people have researched and consulted before they execute, and it’s as simple as that.
Author: Urban Financier