Reasons to invest in your future. Understanding the importance of pensions and savings.
Hello everyone and welcome back to my investing series! This article series is aimed at explaining the many benefits of investing to my readers and at helping them get started. I’m trying to keep everything as beginner-friendly as possible so that even people who’ve never thought about investing can have an idea of where to start.
When I first arrived in the UK as a 27-year-old, not only did I not know a soul, but I also didn’t speak the language. I only knew one thing — that I absolutely need to invest in my future.
Setting up my first business took me the better part of a year, but, thanks to the help and advice of some very knowledgeable people, I managed to get everything off the ground.
Taking control of your personal and business finances can seem a daunting task, but I can assure you it doesn’t need to be. Please keep in mind, however, that I am by no means a qualified financial advisor. If this article inspires you to get into investing, I’d highly recommend that you seek formal advice!
And, remember, no matter what stage you are in your life or career, it is never too late to start preparing for the future!
In today’s blog, we’ll be having a closer look at the differences between passive, active investing and stock market investments and their respective benefits. If you happen to be new to the investing scene (or my blog in general), don’t worry — we’re going to start with the basics and work our way from there! And without further ado, let’s dive right in!
What is investment?
According to stockopedia (a great source of general info and one of my favourite investment-related websites), investment is:
“An asset or item, acquired with the goal of generating income or appreciation”. From an economic standpoint, purchasing anything that you can use to generate money in the future can be called an investment. In finance, the term has a similar meaning — a monetary asset, that you’ll either sell at a higher price or use to generate income in the future.
When you look at it like that, pretty much any item that you’ll have a (tangible and money-generating) use for in the future should be looked at as an investment. Any modern piece of technology, a vehicle, a property or a share on the stock market can be called an investment. In this article, however, we’ll be focusing on the more financial side of the matter. In the next section, we’ll talk about the 3 main types of investing — passive, active investing and investment in individual stocks and shares.
What is passive investing?
The term passive investing is used in relation to putting money towards ETFs and index funds. If you’re looking to do passive investing, you’ll generally find yourself working with low-cost, low-risk opportunities, usually run by an algorithm, attached to a certain sector or index. Widely referred to as the safer and easier type of investing, passive investing allows you to do just what it says on the tin — you put your money in and you can sit back, relax and watch it grow. There are, of course, a lot of factors that you’ll need to be mindful of. You’ll need to
- learn everything you can about brokers (and how to choose them)
- understand the way your savings accounts work (ISA, SIPP)
- diversify your funds — as a rule of thumb, I aim to stay between six and eight (or an absolute maximum of ten) funds. Currently, I’m working with eight.
Which online brokers to choose — you can go with interactive brokers and interactive investors or you can use some of the popular broker platforms like Vanguard (for the UK). The great thing about broker platforms is that you can quickly and easily compare them by taking a glance at their website. I personally prefer Hargreaves Lansdown — I’ll leave a link to their website in the resources section down below if you want to check them out.
As far as my personal investments, I’m trying to do a combination of passive and stock market investing. Half of my SIPP and ISA go towards passive investments, and the other half towards individual stocks.
What are index trackers?
Index tracker funds are computer-operated platforms, that provide you with low-cost and low-risk passive investment opportunities. These funds (and your profit) follow the movement of a given index — as the index rises, so does the value of the fund. And while your profits are going to generally be smaller with index trackers, so are the risks. The complete automation of these trackers means lower fees (as there aren’t going to be too many employees and managers that need salaries) and much lower chance of problems arising down the line (management changes, direction shifts and so on). The average cost of your index tracker fund should not exceed 0.5%.
What are ETFs?
Exchange-Traded Funds (or ETFs as they’re most commonly referred to), are a type of (highly diversified) pooled funds. Most ETFs are designed to track and follow an index, making them an excellent choice for beginners. As most other funds, ETFs own an asset (be it bonds, stocks, or other items) and divides its ownership into shares, sold to shareholders (investors). Unlike their more traditional mutual funding counterpart, however, ETFs can be bought and sold very rapidly, just like stocks. This is because, just like with individual stocks, the value of an ETF can change multiple times throughout a single trading day. They also come with a very low investment minimum and real-time pricing.
What is Active Investing?
Even though I’m not a fan of investing in active funds (and I don’t do it myself), there is a lot of profit to be made here. Active funds are generally managed by teams of professionals, looking to outperform the market in creative ways. And while this does present you with great opportunities, the human element also makes active investment a lot more expensive to participate in.
Active investing pros and cons
In comparison to passive investing, active investing offers you the following pros:
- Much higher potential returns — due to the nature of active investing, it is possible to achieve much higher returns than other methods a lot quicker
- Short-term opportunities — active investing allows you to quickly leverage undervalued market sectors for a quick turnover
- Professional risk management and high degree of control — you have a lot more control over your active investments and can benefit from the help of professional risk managers to mitigate some of the downsides
Cons of active investing:
- Much higher fees — due to the aforementioned human factor, active investment is much more involved and therefore comes with considerably higher fees than its passive counterpart.
- Higher taxes — active investing generally provides more taxable income, making it a bad choice for beginners
- Higher skill floor — active investing requires a lot more knowledge, skills and, of course, initial capital, to get started with
Investments in Individual Stocks and Buying shares on The Stock Market
Investing in individual stocks and shares on the stock market requires analytical skills. You need to be able to read, analyse and understand financial statements well enough to come to the right conclusions. I know that this can sound very intimidating at first, but believe me, after you get the hang of it, it’s not nearly as complicated as it sounds. However, please keep in mind that this is all based on my personal experience! I cannot guarantee that the things which have worked out for me will do the same for you. I am not a financial advisor and I would like to urge to do your own research to find the right approach for your individual circumstances.
There are three types of financial statements that you need to check whenever you’re looking to buy shares in a company:
- Income statement
- Balance sheet
- Cash flow statement
The combination of the three, when coupled with enough knowledge about finance, allows experienced stock market investors to pick out potentially profitable shares to invest in.
For my stock market investments, I also heavily rely on Stockopedia. On their platform, you can find a large number of tools that can help you analyse all the stocks and shares on the market. They’ve also got plenty of investing strategies to choose from. But my absolute favourite part of Stockopedia is that it can help you no matter where you’re located! You can use it to analyse stocks for the UK, for Europe, Canada, America or anywhere else in the world.
Another thing worth considering (especially for beginners) is picking an already prepared investing strategy. The great thing about these strategies is that, for the most part, they will work for you, regardless of your skill level. Sure, a seasoned investment veteran will be able to leverage these strategies to greater effect, but most of them are designed to be useful to beginners and experts alike — you don’t need to know the ins and outs of finance in order to use them!
If you do choose to go with this method, however, I’d highly advise sticking to your guns! Pick a strategy and follow it. I personally prefer strategies for value and growth investment, and, after testing out a couple throughout the years, I can tell you that they’ve worked really well for me!
Dividend stocks can also be a very lucrative choice and a lot of people rely on dividend earnings for a large portion of their income. Just like with other investment types, there is a wide selection of dividend strategies to choose from. I personally work with a mixture of stocks — dividends, valued and growth stocks. I’ve come to really appreciate diversification as the best way of protecting your financial stability.
How to get started with Stock Market Investing in 6 simple steps for Passive and Active Investments:
Step #1 — Master Budgeting
If you’re serious about getting into the investing game, budgeting is really important (and that’s putting it lightly!). As a matter of fact, I’d advise you to look into budgeting even if you aren’t interested in investing at all — it’s just that important of a skill to have!
As with all of my “life changing” advice, I will once again suggest that you begin by introducing small changes and gradually work your way up. For beginners, a good target would be saving 10% of your monthly income and putting it towards your investing.
Now, set a reasonable target for yourself and stick to it!
Step #2 — Choose your investment broker
There are two types of online brokers that you’ll need to choose from — percentage fee brokers and flat fee brokers. The former is better for newbies and investors without a lot of assets, while the latter is more geared towards investors who have accumulated larger sums. If you’re likely to stay below £25 000 in your ISA or £100 000 in your SIPP, and you’re planning on investing smaller sums at a time, you’re generally going to be better off with a percentage fee broker, who’s going to charge you £0 for fund dealings. If you’re going to go big, however, percentage fees can really hit your profits, especially if your broker doesn’t apply a cap. For more information on the subject, I’ve linked an article with the cheapest online brokers for the UK in the resource section down below.
Do a bit of research (I’d suggest using the resources I’ve linked below) and find the right broker for you. Then, invest at least £1000 for 1 individual stock (otherwise the fees are going to be too high), especially if you’re going to be working outside of your own country (exchange fees are also a thing!).
Step #3 — Choose your funds
Pick some suitable index tracker or ETF FUNDS and defersify! Aim to invest in a minimum of 6 to 8 funds, be they domestic and international.
Step #4 — Reinvesting
Generally referred to as a very worthwhile endeavour, reinvesting can allow you to avoid incurring additional broker fees by putting your returns directly back into the fund. Depending on your choice of fund, your reinvestment options may slightly vary. This makes accumulation funds especially lucrative for new and experienced investors alike.
Step #5 — Let it Grow
After setting up your budget, choosing your funds and investing, you will want to let your investments grow. A lot of eager newbies make the error of messing with their investments too often. Don’t overreact to market changes. Instead, be patient and let the fund do its thing. If you do have to make adjustments, try to do it when you can buy low and sell high.
To find out more about the stock market, click here and read my article on its benefits.
Step #6 — Review & Rebalance
Once per year, you can review and rebalance your monthly contributions. You can buy or sell more if you notice significant market shifts.
A few easy steps to start with buying individual stocks
Step #1 — Choose your investment broker — Do a bit of research (I’d suggest using the resources I’ve linked below) and find the right broker for you. Then, invest at least £1000 for 1 individual stock (otherwise the fees are going to be too high), especially if you’re going to be working outside of your own country (exchange fees are also a thing!).
Step #2 — Focus on your budgeting — set a reasonable target for yourself and stick to it!
Step #3– Find a couple of suitable companies to invest in and do your homework well before committing.
Don’t get stuck in only one field! Instead, aim to diversify your investments and branch out across industries. A good investment portfolio is going to have at least 7 or 8 different industries at a minimum of 20 stocks.
Don’t get carried away! While diversification is great, you don’t want to stretch your resources too thin. Going for too many different stocks too fast can interfere with your ability to keep everything in check and stay on top of your analysis.
Step #4 — Reinvest — once your profits start rolling in, don’t just take your earnings out and spend them on holidays or fancy new clothes! Instead, reinvest them back into the fund and allow your wealth to continue growing. If you’re patient enough, in a few years from now, will be able to truly enjoy your financial freedom
Step #5– Rebalance — keep a close eye on your investments and (calmly) react to market changes as they come. Utilise the earnings reports that companies provide to judge your next step.
When to sell:
- When you see that another company has performed better and it seems to present you with better investment opportunities, then you can sell some of your existing investments to buy shares in it
- When the company changes its fundamentals — If the company seems headed in the wrong direction, change their business plan, lose money, or seems to amass more debt than cash, you carefully assess their balance sheet. If they aren’t generating enough cash, it’s time to move on.
- When the stock is overvalued — if their PE is 30-, it’s time to move on.
- When you can tap into a new, more competitive market- tech, for example, is performing really well right now.
- When you feel a recession is just around the corner — this requires a lot of experience to truly judge, and you will never know for sure when this is going to happen, but if all the signs are pointing towards it — it’s time to move on and keep cash!
- When drastic management changes take place — company takeovers, CEO and management team changes or similar events can drastically alter the course of a company, taking us back to point 2.
- When the growth rate of the company slows down, it might be time to look for greener pastures.
- When major political changes occur — if your chosen industry falls under political scrutiny, it’s generally best to cut your losses get out while you can.
When to buy:
- When you have a long term prospective- if you have reason to think that the company will do well in, say, 5 years time, and you are confident that the industry will remain up to par (ask yourself — will there be interest in the given product or field. Good examples of worthwhile companies are: Microsoft, Google, Facebook, Apple, Walt Disney Studios, etc.) Note — there are ways to calculate what the value of your investment will be in 5 years
- When the stocks are stable and understandable
- When the stock is managed by great leaders
- When the stock is undervalued
- When the company hasn’t accumulated too much debt and has a lot of cash (take a good, hard look at the balance sheet, income & cash flow statements)
Taking the time to do a thorough analysis is always worth it! This is real life — you don’t go from rags to riches overnight. Warren Buffet made his first million when he was 56 years old.
Dealing with Stock Market Falls
- Don’t be afraid — market falls (and crashes, for that matter) can and will happen. There’s nothing you can do to stop that and you can’t afford to live in a constant state of fear over them. When the market drops, just remain calm and patient. If and when you do decide to sell, make sure that you’re not selling at a loss.
- Use that time to further study and analyse the company. Figure out if they’ve got the potential to grow in the long-term.
- Try to always buy on sale — just like with other kinds of shopping, you should be trying to get the best deal whenever possible.
- Start small — when you’re just starting out, invest small sums of money and focus on understanding how the business works before fully committing.
How it all started for me
A bit of backstory
As some of my frequent readers probably remember, it was Ivor — one of my first clients in the UK — who sparked my interest in investing.
During my first year in London, when I was still working as a cleaner myself, I had a client named Ivor. He was a really sweet elderly man and, despite my limited understanding of English at the time, we would often have long conversations while I worked on his property. Time and again, he’d advise me to look into finance and try my hand at investing, but, due to my poor English, I ignored his suggestion. “I can barely hold a conversation and he expects me to somehow become an investor”, I’d think to myself. Well, I realised my mistake few years ago. If I had started back then, I would’ve been so much better off today!
I began looking into investment opportunities two years ago. It was quite difficult at first — I had no idea of where to begin or what to focus on. Luck was once again on my side, however, and it wasn’t long until I met Elizabeth — a lovely and knowledgeable lady, who runs investment courses at her home in London. She helped me learn the basics and really opened my eyes to the countless investment opportunities all around me! A link to Elizabeth’s website can be found in the resource section down below.
If you’re trying to get started without a mentor, you can always jump right into it with the help of some already established strategies. As mentioned above, my go-to website for strategies is stockopedia — their platform hosts an entire library’s worth of information, tips, tricks and strategies. You can find a link to their website and YouTube channel below. Furthermore, you can also go to YouTube and search around — there are a lot of completely free videos about investing. These days people share everything online and you can learn a lot without spending a penny.
And that about wraps it up for this article! Join me again next week, when we’ll continue with the investing topic — I’ll share my experience with savings accounts and focus on the importance of ISA and SIPP.
As always, if you enjoyed this article, please let me know by giving it a thumbs up and sharing it on social media. And, if there’s anything that you feel I missed, don’t hesitate to let me know in the comments below!
What about you — have you tried passive or active investing before? How old were you when you first started out? What was the most difficult part of investing for you personally?
Websites and communities
- Stockopedia Main Website
- Elizabeth’s contact details
- Hargreaves Lansdown
- ANN WILLIAMS — The Wealth Chef (an excellent source of free videos and practical financial information, backed up by a stellar community)
- ISA calculator (UK-only)
- The MELO conference website (I attend the conference twice per year and I’ve learned a ton!)
Other Savings Calculators:
- Monevator Article: How to choose an online broker
- Monevator Article: Examples — Lazy Passive Investments
- Monevator Article: What is an Index Tracker
- Monevator — Retirement Plan How-To
- CNBC — Warren Buffet on Index Funds
- Money Saving Expert, Full ISA Guide
More from Warren Buffett:
Additional Books & Audiobooks that I recommend:
- Audio books on Audible — use Audible to listen to the books, if you don’t have time to read.
- Tony Robbins — MONEY Master the Game
- Tony Robbins — Unshakeable: Your Financial Freedom
- Unshakeable: Your Guide to Financial Freedom
- Benjamin Graham — The Intelligent Investor
- David Chilton — The Wealthy Barber
- Robert Kiyosaki — Rich Dad Poor Dad
YouTube Channels and Videos