11 investing questions everyone should ask (and answer)
If you’re already investing or even just thinking about it, then take a bow. You have taken the important and conscious step of sacrificing a little today money to pay for your tomorrow (and hopefully it will be worth more than today.
Once you’ve made that decision, it’s about fine-tuning how you’re doing it. Hopefully this question checklist helps.
1. How much could you afford to invest?
Having heaped on the praise on you for investing, time for a little of negativity – or realism. Don’t invest if you already have expensive debts. The returns you’ll make from investing are unknown. Historically, shares have returned around 5% a year after inflation is taken into account but there’s no guarantee of a repeat. Now look at the rate of interest on your debt. It’s likely to be far higher than 5%. If returns are lower than interest it’s better to clear the debt first. It’s also wise to have at least six month’s worth of outgoings sitting in savings for emergencies, according to the Money Advice Service. The next step is to accurately calculate what you’re earning and spending. This should then tell you how much is left over. Try to invest something, even if it’s small.
2. Have you spread your money around?
You may have heard about eggs and baskets. It’s an overused analogy but with good reason – it’s sensible! Diversifying your investments means buying different types of investments potentially in different regions. It helps balance a portfolio and should mean when one investment underperforms another can help pick up the slack. Having a mix of assets, including some in savings, is a wise approach.
3. How much risk are you willing to take?
There’s a crucial trade-off you face as an investor: take more risk and there’s the potential for more reward. But more risk may mean a bigger chance of losses. If you don’t want to take any risk then you are better off putting your money in a savings account. Returns are potentially much lower but your money is more secure. A back-of-an-envelope risk spectrum might go something like (from low to high): Cash/savings; government bonds, corporate bonds, high-yield corporate bonds, shares, emerging market shares.
4. What you can afford to lose?
This also helps you answer question 3. Part of the process of taking on risk is working out how much you are comfortable with losing. For instance, if you invested £100 would you get sweaty palms if your investment fell 20%? No, what about if it fell 60%? What you’re willing to lose should influence the types of investments you make.
5. What are you investing for?
This is more about the time horizon for your investments but it helps to think about it in terms of what you are investing for. For instance, saving for a holiday tends to be short term so you might not want your money tied up in an investment which can fluctuate wildly and is difficult to cash in. You preferably want more certainty and easy access to your savings. In these types of cases a savings account might be a better option than investing. Alternatively, you might be saving for retirement in which case time is on your side. You can afford to take more risks, because you have more time to allow for any potential losses to be recouped and hopefully built into gains.
6. Are you in for the long-term? And do you have the nerve?
The classic investor error is selling in torrid times and buying during the good times. It tends to be the opposite to buy low, sell high. In fact, trying to time you your entry in and out of the market can prove costly. We’ve run a few calculations on three important UK stock market indices to highlight the point. If you had invested £1,000 in the FTSE 250 in 1987 and left it there for 30 years it would now be worth £24,686. It’s a given, of course, that past performance is of course no guarantee of future returns.
But if you had tried to time your entry in and out of the market during that period and missed out on the index’s 30 best days the same investment would now be worth just £6,878. As an investor, the best thing to do is often nothing.
It is always recommended that you give your investments in the stock market as much time as possible, usually five years or more.
UK stock returns since 1987
Past performance is not a guide to future returns. Source: Schroders. Thomson Reuters Datastream. Data shown is for total return indices, which include dividend payments, between 23 October 1987 and 23 October 2017.
7. Will you reinvest your dividends?
When purchasing a share, you can elect how you want to receive any future dividends. You can choose to receive cash, referred to as income, or use that money to repurchase more company shares, which is known as accumulation.
You must elect to repurchase (accumulate) more shares to trigger the start of a process Albert Einstein called “the eighth wonder of the world”: the miracle effect of compounding.
Compound interest, put simply, is interest on interest and it can help an investment grow at a faster rate. By reinvesting dividends, you give your investment the potential to earn even more dividends in the future, and the process goes on.
The story of Diageo shares is a neat example. The stable profits earned from flogging fancy bottles of spirit to thirsty drinkers have flowed into the pockets of shareholders. Dividend payments to investors have grown steadily, making it easier for us to make the point.
Scenario one - you invested £1,000 on 31 December 1999 (or your mum did). You decided to take all those boozy gains, pocketing the dividends each time they’re paid. Eighteen years later, your £1,000 would be worth £3,368 (equivalent to an average annual return of 7.2%).
However, if you had opted to reinvest the dividends, buying more shares, your current shareholding would be worth £5,996 (an average annual return of 10.8%). The chart shows the two paths.
The same thing can apply to funds. Most funds offer you the chance to buy income units (keep the cash) and accumulation units (reinvesting).
How you investment grows: Diageo shares excluding vs including dividends
Please remember past performance is not a guide to future performance and may not be repeated. Source: Schroders. Thomson Reuters data for the Diageo and Diageo Total Return (including dividends) correct as at 21 November 2017.
8. Have you included inflation in your investing plan?
Inflation is effectively the rising cost of living and it can erode the value of your money and investments.
For example, £100 ten years ago would effectively be worth just £80 in today’s money. That is because of inflation, which has averaged 2% in the UK since 2007. It erodes the spending power of that money.
When you invest, the aim is to grow your money at a rate that will help you meet your goals and comfortably exceed inflation, otherwise you effectively lose money.
9. How much are you paying in charges?
Make sure you know the cost of investing. If you’re investing in shares directly, the buying and selling costs should be obvious – the trading fee. But it’s common to find you must also pay an annual fee or a percentage fee of your assets. Even seemingly small charges of 1% a year can have a significant effect on your investment returns over the very long term.
With funds, the fund management firm will apply an annual management charge or AMC. But the better measure is the total expense ratio or TER, which includes other costs.
As with shares, you may need to pay a broker (also known as a fund supermarket or investing platform) an ongoing fee. These are typically around 0.2% to 0.5% but can also be flat fee amounts. The benefit is you can hold a mix of funds from different fund management companies.
10. Do you have a plan for putting away more?
Not wanting to be a killjoy but the easiest way to do this is to make a commitment that for pay rises and bonuses, a portion of the extra money is directed to your investment account. If you never have it, you’ll never miss it… we never said getting into the savings habit would be all fun.
11. And finally… What age will you/did you start investing?
The benefits of staring investing early are staggering. The earlier you start, the bigger and quicker your savings will grow: compounding (see above) works its magic.
The chart below illustrates how a £50 a month investment could grow over 30 years, so let’s take say investing from age 35 to 65. Assuming your investments grow at 5% annually, you will have amassed savings of £42,456. (By the way, the same £50 put into in a shoebox under your bed each month would result in a shoebox worth £18,600). This is shown in the chart.
Now consider that you started investing at 21, not 35. Your investment pot would, based on the theoreticals above, be worth £72,480 by age 65. By comparison your shoebox would be worth £24,000.
The calculations haven’t been adjusted for inflation, breaking rule 8 above, which is naughty. Sorry. But you get the idea.
How a £50 a month investment could grow over 39 years
Please remember past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
Read more: What can I invest in? Funds for beginners
Read more: Shares vs property: where do I invest?