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Five principles for first-time investing success

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Written by: Stuart Dyer, chief investment officer, Rplan.co.uk
21/07/2015
Investing is complicated – and risky. Markets rise and fall for innumerable reasons and fortunes can be made and lost quickly. The long term returns from markets are generally better than putting cash into savings accounts but it is usually a rocky ride.

Despite the complications, it has become harder in recent years for first-time investors to get personal financial advice. Regulatory changes have made investors with smaller amounts to invest – who often tend to be beginners – less attractive to professional advisers.

As an alternative, there are now many online investment platforms for investors to use, some of which give various degrees of guidance while others require investors to make their own decisions.

First-time investors would be wise to do some homework before they commit any cash. They need to understand a few simple investment principles and be aware of the potential pitfalls. Basic mistakes are easy to avoid and by doing so, investors significantly enhance their chances of success.

The first principle is to set a goal: this can be as simple as knowing how much you want to accumulate and by when. Clearly, investors have to be realistic about how much they can save as an initial sum and/or on a regular basis and what can be achieved. But it is a necessary starting point. Investing in anything other than cash should also only be considered for a term of at least five years.

The second principle is to understand the risks being taken. The greater the risk then the greater the potential gains – or losses. Different types of investment have different levels of risk. Saving in a cash deposit account tends to carry very low risk, other than in situations where interest earned is lower than inflation, in which case the “real” value of the investment may fall. Investing in bonds (such as gilts), property and equities (company shares) carries much more. The shares of small and ‘emerging market’ companies can be particularly risky. While the investments chosen should match the risk appetites of investors, as explained below, this is certainly not always the case in practice.

If first-time investors are young and have a long-term investment horizon then they can afford to take more risk, perhaps including a higher proportion of equities in their portfolios. But is also important to understand what they are investing in, so it would probably be best for them to do so by investing in mainstream stock markets such as the FTSE 100 or the S&P 500 in the US rather than more exotic investments such as industrial sector or emerging market investments. But as investors become more sophisticated they can consider more complex investments, provided they fully understand the risks.

The third principle is diversification: investors must spread their investments to spread the risk. For example, investing in a single equity is much more risky than investing in a fund that covers FTSE 100 stocks.

Fourth, it is important to understand all the charges, which eat into investment returns. The cheapest solution is not always the best, but investors need to know how much they are paying and for what. Charges are usually imposed by both the investment or fund manager and the intermediary through whom investments are bought, such as financial advisers and online platforms.

The final principle is to monitor performance regularly. Far too many people buy investments then forget about them. It is not wise to keep changing investments because of the costs of switching, but if investments are consistently underperforming then investors need to know. Investors should review their investments once or twice a year at a minimum – and make any necessary adjustments.

If investors struggle to find a professional financial adviser or wish to direct their own investments, then using an online investment platform is a viable option. However, if they do then they need to be careful as the quality of platforms varies a great deal and it is hard to differentiate between them.

A report commissioned by Rplan.co.uk earlier this year and conducted by the financial industry expert Andrew Hagger of MoneyComms warned there is a huge disparity between fund platforms used by self-directed investors, with the quality of service levels, competitiveness of charges and the tools available to users ranging from excellent to poor.

For example, Andrew’s analysis of 21 investment platforms found that the annual cost of a £30,000 investment split across 10 funds ranges from £75 up to £219 and averaged £138. Unfortunately, it was hard to determine this as transparency was also variable: only two platforms clearly showed the cost for a £15,000 investment over one year. Other key findings by Andrew included:

  • Although 14 platforms do not charge a fee for exiting, switching or transferring out, account closure fees of between £15 and £25 are common
  • 14 platforms offered neither alerts based on risk nor performance of portfolios, making it more difficult to monitor the performance of investments
  • 14 platforms do not display risk level and cost as part of their portfolio analysis tools
  • Nine platforms do not offer model portfolios and 14 do not offer virtual portfolios

Service also varies dramatically:

  • Six providers took two days to respond to a question about rebalancing a portfolio
  • Only 12 providers gave fully correct responses over the phone to generic questions about ISA limits, cost of investing £10,000 in a specific fund, FSCS compensation levels and service fees

Andrew concluded that several platforms had excellent services and facilities, especially for experienced investors. But that many platforms were particularly challenging for people who were new to investing.

He thought some websites were cluttered and far from user friendly whilst others seemed more focused on promoting additional services and displaying intrusive advertising than giving the user a straightforward journey and a means of building and maintaining a portfolio from scratch.

Andrew’s paper highlighted the importance of matching investors’ portfolios with their risk profiles in a transparent and flexible way and ensuring they are kept up to date on how their investments are performing. This is crucial to delivering value for money for investors but it is a concern that delivery of such service levels is sporadic across the platform sector.

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