Back to school – the A-Z of investing

As children return to the classroom with new parts of the curriculum to explore, newcomers to investing might like a teach-in of their own.

While savers face a challenging economic environment at the moment, investing is still important for those looking to grow their wealth over the long-term.

We go back to basics with a must-have A-Z of investing.

A

Active investing

This is where a fund manager handpicks companies to invest in, with the aim of delivering a performance that beats their benchmark goal. Together with a team of analysts and researchers, the manager will ‘actively’ buy, hold and sell stocks to try to achieve this goal.

Asset allocation

When you invest, you must decide how much of your money you want to allocate to different assets. Assets are the things you’re investing in, such as shares, bonds and cash. It’s good to have a mix because they each perform differently and it’s a way of reducing the overall risk you’re taking. You decide on what the right investments are for you depending on your timescale – how long you plan to invest, your investment objectives, and your approach to risk.

B

Bonds

Bonds and gilts are IOUs issued by governments and companies looking to raise cash. By investing in a corporate bond you’re loaning a government or company money for a fixed number of years. In exchange for your cash, you earn a regular fixed rate of interest. When the bond’s life comes to an end your original capital should be repaid in full. Like shares, you buy and sell bonds on the market, so although the income is fixed the value can go up and down.

C

Compounding

In simple terms, when you invest your money will hopefully increase in value and you’ll earn a positive return most years. Assuming it does, after the first year, both the original capital and the return benefit from any further returns in the second year. In the third year your investment is further enhanced by any returns achieved, and so on. This snowball effect is known as compounding. So if you invest £10,000 and achieve a 4% return each year, it would be worth £10,400 in year two, £10,816 in year three, and so on.

Compounding can turbocharge your returns – so long as you have plenty of time on your side.

D

Diversification

Diversification means investing across a wide range of different asset classes, geographical areas, and economic sectors to help reduce the overall risk of losing money. Split your investments between shares and bonds – which don’t always move in the same direction – as well as cash and alternatives such as property and commodities, where appropriate. This gives protection from different market and economic conditions and spreads the overall risk you’re taking, helping to smooth out your returns – if some of your investments are going down in value, you’ll hopefully have others that are going up.

In a way you can think of the idea of packing the car boot up for holiday in the UK. You don’t just pack beach gear, you include waterproofs, card games and woolly socks. Your ability to adapt to the changing weather once you are already there is limited – the weather changes quickly, without warning. Therefore, you use you limited boot space (standing in here for your savings) extremely carefully, being sure to pack warm and wet equipment in proportion to your expectations of the chances of wet/dry weather. In markets, unpredictable weather is very much part of the short-term story for investors. That is why we painstakingly include the asset allocation equivalents of warm clothes, indoor games and so on, to try and prepare your savings for the days when fair weather seems some way away.

E

ESG

This stands for environmental, social and governance. ESG investing is where you ensure the company you want to buy shares in, or fund that invests in companies, adheres to good practice for one, two or all three components.

F

Fund

Instead of buying shares in individual companies it’s possible to invest in a fund which offers the opportunity to invest in lots of different companies. Money is pooled with that of other investors and the fund manager will then invest it on your behalf – see ‘active investing’ above.

G

Growth funds

Growth funds will typically choose to invest in companies that they believe will be able to significantly grow their earnings over time. They target firms that reinvest their dividends in their business rather than paying out profits to shareholders.

Some managers prefer to invest in smaller and medium-sized companies, believing there is more opportunity for growth. Alternatively, you can go for income funds where managers seek out and invest in companies that they see as having the potential to pay consistent and growing dividends. As a result, you may receive an income from your investment at regular intervals which you can take or reinvest.

H

High Yield Bond

High yield bonds are those from companies with lower credit ratings. They offer higher yields because there’s a greater risk they might default on an interest payment or not be able to repay bondholders in full. High yield bond issuers are often smaller companies in more niche, specialist areas.

I

ISAs

ISAs are an all-important tax wrapper where your money grows free of income tax, capitals gains tax and there’s no tax due on dividend payments. You don’t even need to mention it on your self-assessment tax return. In the current tax year 2023-24 you can place up to £20,000 in an ISA.

J

Junior ISA

Like adult ISAs, the Junior ISA comes with a limit for each year. The rules allow you to save £9,000 in a Junior ISA for the current tax year 2023-24. The idea behind the Junior version was to give parents a chance of building up a meaningful fund for children who could gain a helping hand with university costs or buying a first home.

K

Key Investor Information Document (KIID) / Key Information Document (KID)

These documents are produced for different types of investment products and give you vital information such as their objectives, targets, strategy, risk profile, charges and performance figures. The aim is to help investors understand the nature and key risks of the product to help them make a more informed investment decision.

L

Long-term

The longer you’re prepared to stay invested, the greater the chance your investments will increase in value. We suggest you should invest for at least five years, because stock markets go down as well as up. If you only invest for a short period of time, there’s more chance that you’ll lose money because if the markets fall, you may not have time to wait for them to recover before you need to access your money.

Time in the market, not timing the market, is what contributes to building wealth.

M

Market index

A market index tracks the performance of a certain group of stocks, bonds or other investments. The most well-known in the UK is the FTSE 100 which lists the 100 largest companies listed on the London Stock Exchange. In the US there’s the S&P500 (the 500 largest firms) and the Nasdaq.

N

Nest-egg

This is an old-fashioned term for your life savings that you have earmarked for “the future”.

O

Ongoing charges figure (OCF)

The OCF gives you an idea of how much you’ll pay to have an investment in the fund over one year. You don’t pay it as a separate fee though, as it’s deducted from the value of the fund’s investments. As well as any Annual Management Charge (AMC) taken by the manager for their investment services, it includes the other main ongoing costs that were taken from the fund in the previous year.

P

Pension

A pension provides a unique way of saving for retirement. You get tax relief on contributions and your money can grow tax-free. You can access the cash at age 55 (57 from 2028) and typically can take 25% tax-free. Withdrawals after that are subject to income tax. There are several types of pension including a company or workplace pension and a Self-Invested Personal Pension (SIPP). Most people will have a company pension from their employer, but with a SIPP you make the investment decisions yourself and can choose from a wide range of investment assets, which can be an attractive option to those who want to take a more hands-on approach. You can also have a SIPP as well as company pensions.

Q

Question

Ask yourself if you’re ready to invest and spend some time thinking about what you’re investing for, how much you can afford to put away and do you want to invest a lump sum or make regular investments. Remember you can change your investment approach at any time.

R

Ready-made investments

If you’re not sure where to start, or are short on time, a ready-made investment fund could be a good option. They invest in a mix in shares, bonds and cash to help spread risk and give you immediate diversification but they usually differ in terms of the level of risk they take, so you just need to work out which is most appropriate for you.

S

Shares

Companies issue shares as a way to raise money. When you buy shares, you effectively become a part owner of the company. Holding shares in just one company can carry higher risks than investing in funds which invest in shares of many different companies because your fortune is dependent on how that one company performs. In order to reduce the risk you could buy shares of multiple companies, or invest in a fund which will do that for you.

T

Tracker

Unlike active funds where a manager picks the investments, tracker funds – also known as passive or index funds – simply follow the overall performance of a particular market or index, such as the FTSE 100.

U

Underperformance

This is where a fund or share produces a smaller return compared to other similar companies or funds.

V

Volatility

Volatility is the movement of share prices. People worry when there are big swings in the short term. Long-term investors are urged to ignore short-term movements and focus on longer term trends.

W

Wrapper

This describes a tax shelter or wrapper for savings and investments such as an ISA or SIPP.

X

XO -Execution only

This is an investment service where you make your own investment decisions without receiving advice. There will usually be research information, articles and videos as well as tools and calculators to help.

Y

Yield

This is the financial calculation, usually expressed as a %, of the return generated by holding shares in a company or fund.

Z

ZZZZ – Snooze you lose

When it comes to getting started with investing, it’s never too early. If you snooze you could lose out on a long-term opportunity to grow your wealth.