Photo: taken by me, in Ediba

Investing for Rookies

Finance Feb 2, 2021

If you're new to the world of investing and have no idea where to start, this should be a useful primer.


Let me start with the least sexy thing you’re going to hear me say. It might not be what you came here to hear, but you need to hear it.

Before you begin

The easiest way to invest is to pay off your debt. This includes any overdrafts. If you have a credit card with a 9% interest rate, every month you make a payment towards that you’re making a 9% investment in yourself and in your future.

You’re directly increasing your net worth in THREE ways. First, if you’re paying against the principal your net worth has just gone up by the exact amount you paid. Second, your net worth has technically also gone up by 9% of that number. Third, every month you repay debt you are taking a step closer to increasing the likelihood of obtaining credit in future - if you want a house or a business loan later every payment you make now is helping you later.

This is the checklist I’d typically start with before looking into investing speculatively in stocks, bonds and other instruments:

  1. Do you have an emergency fund? Start here first!
  2. Do you have any high interest debt? (anything above two digits). Invest in paying it off.
  3. Are you contributing to your pension (UK) or 401k (US)? - Start here and at minimum, invest whatever your company will match. In the UK if you’re self employed (or think you know better than your company) you can put your money in a SIPP instead.

All good? Awesome.

Investing Basics

You can invest in almost anything - you’ve got stocks, bonds, funds and treasury bills, as traditional sources, but also art, cars, wine, property, even streetwear. People are creating new financial products all the time. These days even footballers have been turned into commoditised stocks and you can trade and speculate on their value week to week. The spectrum of possibilities is immense.

However, where there’s money to be gained there is money to be lost. All investments are a gamble. And many investments are zero sum games meaning that for every winner there are losers.

As a general word of caution, only invest what you can afford to lose and please be aware that you could potentially lose everything you invest. With some products you can even lose more than you initially invested, so it’s worth being very careful about the products and markets you pick.

It’s always wise to diversify your investments as much as possible - as the saying goes, don’t put all your eggs in one basket. Don’t take your life savings and dump it all into stocks of your favourite company. That company could tank tomorrow and suddenly you’re on GoFundMe trying to raise enough change to buy a multipack of ramen noodles.

Bonds explained:

A bond is basically an IOU - you give a loan to a company or government entity, and they agree to pay you back in a certain number of years. In the meantime, you get interest.

Bonds generally are less risky than stocks because you know exactly when you’ll be paid back and how much you’ll earn.

With bonds the main risk you’re taking is that the company won’t go bust before the bond matures - so you want to pick a healthy looking company that looks like it will, at the very least, be around long enough to give you your money back.

The second risk with bonds is that they’re very illiquid - this means that if you buy a bond for 5k, it’s usually unlikely you’ll be able to get that money back quickly if you’re in a pinch and suddenly need the money. Despite both of those though, as long as the company remains fully operational you should get your return when the bond matures.

Stocks are just a different kind of bet. Instead of betting that the company will still be around long enough to redeem bonds, you’re betting on the total current value of the company.

Stocks explained:

Investing in stock markets is a gamble: while you could win small or win big, you could lose small or lose big – and end up empty-handed.

A stock is a share of ownership in a company. It’s a piece of equity, although many large companies can have hundreds of thousands of shares so it’s not like you’re getting access to Apple board meetings because you bought a single share over the weekend.

Stock prices generally move based on investors’ evaluation of the company’s performance. This includes leadership changes, new product releases or how it’s doing financially.

When companies initially offer fresh stock they get to set the price, but after that the price on any given day can be determined by financial results, the country’s economic health and market 'sentiment'.

Things to remember

The greater return you want, the more risk you'll usually have to accept.

Don't be tempted to sell or buy shares just because everyone else is. Don’t buy hype stocks for the sake of it.

Hopefully I haven’t scared you off the idea of investing, it’s just important to know the risks before we get to the rewards.

A big key to minimise your investment risk is to diversify.

Don't put all your eggs in one basket. Try to diversify as much as you can to lower your risk exposure, ie, invest in different companies, industries and regions.

invest for at least five years. If you can't, it's often best to steer clear of investing and leave your money in a savings account.

What you need to invest

A popular misconception I have been trying to debunk for a while is the idea that you need to be rich to invest. Most people think of investing and they’re thinking of Warren Buffet and all the white middle class men in suits.

However on the contrary, investing can be a great tool for those with more modest savings who want to grow that pot over the course of their lives. Of course, don’t invest anything you can’t afford to lose, but even if you have £10 a month to spare, investing can be both realistic and worthwhile.

It’s actually possible that many smaller investors, who 'drip-feed' small sums on a regular basis, can do much better over time than those who simply dump a big lump sum into the market. This is known as dollar-cost averaging.

This is because investing regularly over a period of time gives you long enough time to ride out bumps in the market. And then on top of that you still benefit from the snowball effect of compound interest.

Share The Knowledge

How to start picking

So let’s say you’ve decided to get started - the first thing you’d need to do is pick which platform to buy your shares or funds from, then you need to decide what investments to buy.

To use an analogy, imagine you want to buy bread from the shop. Assuming you know the type of bread you want, you’ll need to decide where you want to buy it.

If the bread you want is your ultimate investment choice, the supermarket would be your platform. Once you know where you want to shop you then have to think about the type of bread you want to buy.

I’m going to need you to try and stay with me because this analogy is about to dive down a rabbit hole but I promise it will be well worth it.

Let’s get this bread

In a supermarket when you’re buying bread your first choice is generally between freshly made bakery bread and pre-packaged bread. Our bakery bread here is like picking individual stocks. When you’re buying fresh bread, obviously you can’t pick it up with your hands unless you lack manners, but you’ll definitely inspect it closely.

Each bread in the bakery section might have a slightly different flavour, texture, size and shape. Some have seeds in, some have cheese on; Is it a bagel, is it a croissant, or a bap? Some of them are clearly different, but many of the things in that section might also look similar at first glance, until you check the label and realise it’s not what you wanted. In the same way, you really have to take care in picking individual stocks because no two are identical.

What about funds?

The packaged bread however, is more like funds. Inside each pack is several slices of bread and you can be safe assuming that each pack from the same brand will be identical. Most of the time you’ll be buying the product for the brand based on how it’s differentiated, rather than all the specific ingredients.

A fund is just another way of buying shares, but instead of buying them individually, fund managers buy a few different stocks wholesale and hold on to them. Then, instead of buying each individual stock you just buy units in the fund itself, and that will give you a smaller chunk of all the stocks they own. This helps you diversify.

And just like a stock, the value of your units go up and down based on how well the fund is doing. They’re generally measured by how well they can pick stocks, so if you don’t know enough about the individual stocks it can work well just to buy units in a fund and let them pick the stocks for you.

That’s not the end though - there are two types of funds. Actively managed funds would be like getting brand-name packets of bread, and passively managed funds are like getting own-brand bread.

So what’s the difference?

At the end of the day they both have bread right? In fact they could both be using the exact same ingredients. However the difference emerges over time. In an actively managed fund, the fund managers will continually be monitoring it’s performance and changing the ingredients in response to changing market conditions. In a passive fund however, the ingredients are picked in advance and stay the same.

The fund will decide what proportion of it’s whole will be made up of which stocks or markets, and as those markets change in value, individual shares will be bought and sold to maintain the same balance.

So if the recipe calls for 5% Japanese automobile stocks and 3% US agriculture stocks, if the automobile starts doing really well the fund may rebalance your portfolio by selling some of the shares to make sure your total exposure to that market doesn’t exceed 3%. Hopefully that all makes sense.

It’s not as bad as it sounds though, and despite one being called active and one being called passive, passive investments are no slacker. In fact, many statistics show that passive funds usually outperform active ones over time. They’re also cheaper because they don’t require much looking after.

What about fees?

Once you’ve figured out which bread you want you’ve also got a third consideration - your fees. This may sound like such a tiny microscopic thing but it’s definitely worth considering.

If you invested £10,000 and it grew five per cent each year with annual charges of 1 per cent, in 10 years your investment would be worth £14,802. That’s pretty impressive. But over that same period, if your annual charges were just 0.5 per cent a year, that amount would be £15,530 – that’s £728 more.

In this analogy the fees are a bit like choosing a shopping bag. For some, picking the cheap flimsy 5p bag in Tesco will do exactly the same job as getting a £2 tote bag in Marks and Spencer. However, if there are specific perks you get from shopping in M&S, it might be well worth it for you to pay a little extra in fees. Similarly, there are people who may prefer paying a premium for the client handholding and cultural cache you’ll get with a more traditional fund manager, rather than the simplicity of a flashy Roboinvestor or self-managed platform.

Share

Speaking practically

When you start dipping your toes into the world of investing, it’s best to invest in a way that will minimise taxes on your gains. There are plenty of easy, legal ways to do this. If you’re in the UK, use your pension and an ISA. If you’re in the US, use your 401k and Roth IRA.

In the above Twitter thread I break down the pros and cons of going with a roboadvisor vs fund manager vs going it alone completely. For clarity, I do all three in different portfolios. My best recommendation for getting off the ground quickly and easily though, is Nutmeg.


I hope you found the above helpful!

If you have any thoughts, questions, or feedback, I’d love to hear from you! Reply via email, leave a comment or send me a tweet!

This wasn’t an official issue of my newsletter, so if you want to see my regular insights, please subscribe!

Photo: taken by me, in Ediba
Photo: taken by me, in Ediba

Resources:

  • Nutmeg - In the last 10 years I’ve tried about 8-10 different investment platforms but Nutmeg has the best mix of super-simple plug and play operation, with great returns (so far). You can use this link to get 6 months without fees :)
  • Freetrade - One of the most popular places to easily trade individual shares online. You can get a free share worth up to £200 just by signing up, which is pretty sweet.
  • Audible - I’m on course to finish at least 11 books in the first 5 weeks of this year (number 11 will be a sure fire recommendation next newsletter). Make the most of the daily/weekly deals and start your digital stockpile!

Tags

Great! You've successfully subscribed.
Great! Next, complete checkout for full access.
Welcome back! You've successfully signed in.
Success! Your account is fully activated, you now have access to all content.