Before deciding on the type of investments to make, you should think through the following questions to help you make the right investment plan for your circumstances:
1. What are your financial goals?
Start off by establishing your overall financial goals. Short-term goals might include buying a car or putting money aside for a deposit for a house in the next two or three years.
You might have medium-term goals, such as building up a fund to support your children, or going on a once-in-a-lifetime holiday.
Long-term goals might be to start investing in a personal pension to supplement your state pension.
It’s important to set your financial goals at the outset so that you can match the most suitable investments in terms of time periods, together with their associated risk and returns.
2. How much can you afford to invest?
Having put aside money for a rainy day fund, the next decision is how much to invest.
It’s a good idea to work out whether you have money left over at the end of the month after paying your expenses. If so, you might want to consider investing a regular amount every month to build up your investment pot over time. Or you might look at investing a lump-sum such as a bonus or inheritance.
Whichever option you choose, you should work out the amount of money that you are able to invest and whether you might need to access this money in an emergency.
3. How much risk are you willing to take?
On the whole, there is a correlation between risk and return – investors who are willing to take on a higher level of risk are potentially rewarded with a higher level of return.
Government bonds or ‘gilts’ are considered low-risk investments and currently offer a return or ‘yield’ of 1-2% (based on their current trading price).
Investing in the stock market is higher risk but the FTSE All Share index has produced an average annual return of 10% over the last 30 years, according to Vanguard Asset Management.
Within the stock market itself, there’s a wide variation in risk and returns. For example, among the 57 investment sectors, Latin America has delivered one of the highest returns of 5% to date in 2022 – but after posting the lowest returns across the sectors in the previous two years, with negative returns of 12% and 15% in 2021 and 2020 respectively, based on data from Trustnet.
4. What is your time-frame?
Having decided on your financial goals, you should work out how long you want to invest your money for. In general, you should look to invest for at least five years – stock markets can fall, as well as rise, and this helps you to smooth out the average returns.
Investing for less than five years can present challenges. If you need to access your money at short notice, and your investments have temporarily fallen in value, you may be selling them at a bad time.
If you may need to access your money in the next few years, you’d be better advised to keep your money in savings accounts where your capital is protected.
By the same token, if you are looking to invest for a longer period of time, such as for a pension, you may choose higher-risk options as your investments have time to recover from any dip in value.
Whatever your chosen time period, it’s wise to change the balance of your portfolio as you approach the time to sell the investment. Selling a proportion of your stock market investments over time, and depositing the proceeds into a savings account, protects your money against a short-term fall in the stock market.
5. Are you looking for income or capital growth?
There are two types of return on investment – ‘capital’ growth (an increase in the value of your investment), and income.
With a savings account, you receive an income in the form of interest. With investments, it usually takes the form of dividends – these are cash payments made by a company to shareholders, usually on a yearly or half-yearly basis.
Although many people invest in the stock market for capital growth, the ability to produce an income stream can be useful. For pension investments, an income stream can be used in retirement, while leaving the capital invested to grow in value and produce income in the future.
However, there can be a trade-off between income and capital growth. Some of the high-growth, US technology companies choose to reinvest surplus profits rather than pay a dividend, which should theoretically lead to higher capital growth. In contrast, some lower-growth, blue-chip companies in the UK pay regular dividends to shareholders.
You can usually buy ‘income’ or ‘accumulation’ units if you’re buying a fund-based investment. With ‘income’ units, any dividends or income are paid out in cash to investors, whereas this income is reinvested to buy additional units under the ‘accumulation’ option.
