Investment Masterclass: Essentials

Welcome to week 2 of our six-week Investment Masterclass. I’m Susannah Streeter, Head of Money and Markets at Hargreaves Lansdown. This week we’ll start the journey of understanding the role of investing within your financial strategy, understanding risk and how investing can complement your savings.

Remember, this course is for educational purposes and none of the information shown is personal advice. If you’re unsure what’s right for you, please ask for advice.

Should I save or invest?

Before the pandemic, it often felt that in the investing game the table was reserved for wealthy city boys. More recently, investing has taken hold more widely. In fact, the average age of a person using the HL platform dropped from 54 in 2012 to 40 in 2021, showing a new engagement from younger generations.

Whatever your goals, saving and investing are ways to tuck away money now, for the chance to have more in the future. Put in just a few words, we invest to make our money work that little bit harder for us.

The question to consider now is should I save or invest?

When should I save?

There are a few good indicators for when you should save, such as:

• When you have a short-term goal in mind where you’ll need the money within 5 years, like a holiday, wedding or even a house purchase
• It’s your just-in-case money – if the boiler breaks, or you’ve had a change in circumstance – a good rule of thumb is to have around 3 to 6 months of expenditure
• You want to be able to access your money straight away

When should I invest?

You’re in a good position to invest when:

• you’re willing and able to accept a level of risk – and won’t need the money for at least 5 years. With investing, there’s no guarantee of making money and you could get back less than you invest
• you want the chance to grow your money more than you could with cash
• you’ve saved a supply of cash that you can access easily for emergencies

Investing can come in many forms, but investors can be broadly split into two camps – short-term speculators and long-term investors.

Speculators try to predict the market’s next steps. They regularly chop and change their investments based on the latest news or market trends, with the aim of profiting from small changes to share prices. Timing the market like this is notoriously difficult. Speculators’ time horizons can range from a few days, up to a few months.

The opposite end of the spectrum are long-term investors. We think it’s sensible for most people to sit firmly in this camp. These investors want to benefit by spending time in the market. They pay less attention to short-term market hustle and bustle, and aren’t too worried about what happens to share or fund prices today or tomorrow. Instead, long-term investors try to look two steps ahead – backing companies they think have the potential to perform well over the next five to ten years.

One of the main differences between cash saving and investing is the level of risk you are taking on. Risk with cash is fairly low, but never zero. Cash can struggle to keep up with inflation, so you could lose money in real terms over the longer term.

Managing this risk is vital and wide ranging when considering investing. Let’s take a look at risk in a bit more detail.

What is risk?

‘Risk’, in terms of investing usually means the market ups and downs, known as volatility, you’ll experience along your journey. The opportunity is the chance your investments could rise in value over the long term – growth you can't match from cash in a bank account. The ‘cost’ of this risk is uncertainty, patience and the chance you could get back less than you invest. All investments will rise and fall in value, that’s their risk.

Different investments carry different risk and we’ll look at these and how to manage risk in more detail later in the Masterclass. Having a better understanding of the risk you’re willing to take will help with your decision-making process further down the line.

Golden Rules of Investing

Considering all of the above, when you do decide to invest, there are three golden rules to follow to help you balance the opportunities and the risks.

1. Higher risk doesn’t always mean higher reward

You might’ve heard the phrase “high risk, high reward” before? The phrase gets bandied around a lot, but it doesn’t always hold true in the investing world.

High risk (volatile) investments – such as shares in smaller companies – do have their place in investing and should form a small part of your overall portfolio. That’s if they’re something you’re considering in the first place. However, stock markets don’t always perform as you’d expect.

As investments become more speculative and therefore more unpredictable, the likelihood of picking a loser becomes just as great as picking a winner. While more risky investments have a higher expected return, the opposite is also true – the expected losses are much greater too.

Managing your risk is a key foundation to building and maintaining a successful investment portfolio. Weighing up the risks and rewards linked with different investments should form a big part of your decision-making process. When it comes to managing risk, diversification is crucial.

With diversification, you spread your money between different investment types to reduce the overall impact of risk when investing. It’s used to help smooth out the ups and downs your portfolio could go through if you hold too few, or too similar investments.

We’ll go into more detail on diversification in later sessions as we explore the different types of investments.

2. It’s about time in the market, not timing the market.

Taking a long-term approach with your investments helps cut out the short-term noise and with it, the worries about finding the right time to invest.

Waiting for the right time to invest or tinkering too much with your investments can mean you miss the market’s most fruitful days.

In reality, which way the market moves today, tomorrow, or next week doesn’t really matter when investing long term. What matters is you stay invested and diversify your investments across areas you think will perform well over the next 5-10 years.

The longer you give your investments in the markets, the more they are also able to benefit from the magic of compounding. Remember though, all investments rise and fall in value so you could get back less than you invest.

Compounding is your most powerful tool in investing, but it can be the easiest to overlook. Getting your head around it is the hardest part – after that, it does the work for you.

Imagine this. If you fold a piece of paper in half 27 times, it will be taller than Mount Everest. And if you folded that paper just a few more times, you would reach the moon.

How is that possible? Because each fold effectively doubles its height, which is tiny at first - just a few sheets thick - but as you keep folding, your piece of paper soon becomes miles tall. You’re not starting again each time – you’re building upon a base that already exists.

Compounding is just as applicable to money as it is to paper. Allow any increases in your investments to be reinvested and build upon themselves. Not touching it for the long term takes patience but the results really could really pay off.

So long as you check you’re diversified enough, and your investments are still in line with your goals, time will do the work.

3. Invest little and often

We think investing little and often is a great tactic for many investors. Not only does it offer an affordable way to build the size of your investment pot, committing to invest something on a regular basis builds good habits.

Investing on a regular basis can also reduce the risk of volatile markets where share prices can move up and down in value sharply.

By drip feeding your money in the market at regular intervals, you benefit from pound-cost averaging. A long name but a simple idea. The theory is you buy fewer shares when prices are high and buy more shares when prices are low. Over time, this should average out the price you pay for investments. It’s worth noting, stock markets don’t always harmonise with theories so pound-cost averaging can work against you if prices rise and never look back. Investors could be better served by investing a lump sum in this scenario.

However, we know markets tend to move up and down in the near term. The law of averages suggests investing monthly should even things out over time.

If you want to invest regularly, consider setting up a Direct Debit.

Investing monthly can be beneficial for a few reasons.

• It helps take the emotion out of your decisions
• You’ll benefit from ‘pound-cost averaging’
• It’s good investing discipline

Now we've completed the second lesson, take a few moments to complete the quiz at the bottom of the page and check your understanding of what we've covered.