For the virgin investor, a well-meaning cursory internet search to find out how best to invest your savings throws up a whole minefield of considerations. Words that never feature in day to day English language suddenly flash up. This can cause even the most dedicated virgin investor to flee into the arms of the local high street bank manager – who can provide a friendly face but crucially, can only guarantee very poor interest rate returns.
The first step is the most difficult step for the virgin investor but fortunately, in recent years, even this has become easier through investing in funds (the product) on an online fund trading platform (the platform). We will focus on the concept of funds for this article.
Starting with funds. Funds are a collection of a number of different assets that individual investors can buy into. A typical fund may consist of a number of different company shares from around the world, government bonds, commodity investments and more. The idea is that if the fund asset allocation is spread over a number of different assets and asset types, the risks of investing are decreased as it is unlikely that all assets will perform badly all at once. This makes funds a great entry point into the world of investing. There are two types of fund:
Active fund: Actively managed fund meaning that an asset management team takes responsibility for increasing return and reducing risk. In return, they are paid a management fee which is usually a percentage of the amount of money you have invested with them.
Passive fund: Passively managed funds invest your money to follow a particular asset type. A typical example is in a passive fund that tracks a national share index. The fund will automatically invest in the companies on the share index and so the value of the fund will rise and fall with the share index. As this is more automated and requires less management, the management fee is typically lower.
By investing in a fund, your money is automatically spread over a number of assets so risk (and return) in theory are reduced – this is a very good start. However a fund usually focuses on one particular asset area (eg. Shares in a particular country) and so to further reduce risk, you can invest in a number of different funds across a variety of different asset types, sectors and/or countries. This is known as diversifying your portfolio. Here are a collection of a few asset types and their relative risk weighting:
Shares: Global Emerging Markets
Shares: UK smaller companies
Shares: All UK
Shares: North America
UK Index Linked Gilt
UK Corporate Bond £
The funds you invest in will depend on your appetite for risk and returns. In a free trading market, the concepts of risk and return are strongly proportional. For investors who want higher returns, they will have to stomach higher risk and vice versa. For the virgin investor starting out in funds, the aim should be to diversify your portfolio sufficiently to limit the chance of a major shock.
Remember the first step is the most difficult but funds may just provide the door into the world of investing that so many would love to walk through.