Contrary to popular belief, investing is not just for the rich, and is accessible to anyone wanting to grow their wealth. There is no minimum starting amount in the case of investing for beginners in 2021, and you can build your capital over time. All you need to do is make a start, no matter how small, and then raise the investment levels as you become more experienced in the field and have more cash to invest.
What is investing?
Investing is the act of buying securities such as company shares, fixed-rate bonds, commodities, index funds, and other investment vehicles, with the expectation that the value will grow over time. The goal of investing is to create long-term wealth by building a portfolio that will maximise profits from capital gains and dividends while minimising the risks.
Why should you invest?
Investing is suitable for everyone, whether you have a large amount of capital or are starting with a smaller sum. The biggest reason to invest over keeping your money in a savings account is that the interest rates in banks are at record lows.
Meanwhile, inflation is running ahead of interest rates and eroding the buying power of cash-saving pots. For example, according to the Office for National Statistics (ONS) UK Composite Price Index, prices in 2019 are 150% higher than in 1989, with the real value of the British pound decreasing by 3.1% per year on average during the 30 years. In other words, the purchasing power of £100 in 1989 is equal to £250 in 2019. Therefore, by keeping your cash in savings you are allowing it to lose its value. Stocks, on the other hand, have a reasonable chance to keep in pace with inflation.
What can you invest in?
In essence, there are three main asset classes for investing for beginners in 2021: cash and equivalents, company shares, and fixed-income bonds. But investors can also get exposure to commodities, real estate, currencies, and more in their asset class mix.
Investing in stocks
When buying a share or a stock of a company you are buying its equity ownership. That means you now own a slice of the firm and are entitled to capital appreciation and dividends.
Dividends are a form of reward to the shareholders for putting their money into the company and can be paid in cash or additional stocks. Dividend payments are distributed from the company’s earnings, and not every firm can afford or prioritise dividend payments. Investors may reinvest their dividends further to increase capital gains.
Unfortunately, in the current economic environment with many companies hit by the pandemic, dividends are being slashed to preserve money and weather the storm. According to Link Assets, UK dividends plunged by 57% in the second quarter (Q2), and are predicted to fall by 40% in 2021.
It’s important to note that stock prices go up and down, and there is no guarantee of future returns. Fortunately, over the past century, the UK equities have experienced a strong uptrend. According to the Barclays Equity Gilt study, £100 invested in equities in 1899 would now be worth around £2.7m, as compared to £20,000 when invested in cash, or £42,000 when invested in gilts. Despite this, shares are still considered ‘high-risk’ assets as unexpected events outside of your control can affect a company’s performance and bring volatility to the share price. However, there are ways to mitigate these risks such as diversification.
Investing in fixed-income bonds
Bonds are used by investors around the world. In its essence, bonds are loans issued by a government or a company to bring in new funding. Investors who buy into bonds receive a fixed interest rate paid either monthly or quarterly for the loan duration. At the end of the period, which can vary from three months to 20 years, investors receive their money back.
Bonds sit up higher in the capital structure than stocks, meaning bondholders get paid first, which makes investing in bonds a safer bet than shares. However, as with any loan-based investment, there is still a risk that a company or a government may fail to pay back at the end of the term. Therefore, it is crucial to review the risk status of a bond via a credit rating company before buying. The best bonds will have a credit rating of an A or higher and would offer regular inflation-beating returns.
Investing in commodities
Commodities are tangible assets that you can invest in to diversify your portfolio. They vary from precious and industrial metals such as gold, silver, and copper, to energy markets such as oil or natural gas. You can get direct exposure to a commodity by buying Exchange Traded Funds (ETFs), which will be explained in the next section, or you can invest in commodity miners and producers. The commodity market is volatile, and you should do your research before getting in.
Exchange Traded Funds (ETFs) and index investing
Indices are baskets of securities that replicate certain areas of the market. For example, many benchmark indices mirror the performance of the biggest publicly listed companies in a country, such as the FTSE 100 in the UK. Index-tracking funds reflect the weighted price of the companies included in the index.
ETFs are similar to mutual funds in the way that they can mimic indices and contain multiple underlying assets, but there are some principal differences between the two; as their name suggests, ETFs trade on exchange on a per-share basis with the price fluctuating throughout the trading session. Meanwhile, mutual funds trade only after the market closes and tend to have higher commission fees than ETFs. The constant trading makes ETFs more liquid as they are easier to get in and out of.
Since 1993, the range of available ETFs has exploded with almost 7,000 listings in 2019 according to Statista, and ETF flows exceeded those of mutual funds in 2003. ETFs have become one of the most popular investor vehicles as they cover a wide variety of sectors and contain all types of asset classes, including stocks, bonds, commodities, real estate, currencies, and international investments. There are also inverse ETFs, which trade in the opposite direction, and leverage ETFs that magnify results. Using ETFs investors can build a diversified portfolio with lower capital and fewer trades than they would have been required in the past.
