Investing usually earns you better returns than a savings account over the long term, although there are no guarantees. Here, we run through the options available, from pensions to share dealing accounts, to help you choose the best way to invest your money, whether you’re saving for retirement, a house deposit, or a family holiday.
Investing means that your capital is at risk. Investments are not guaranteed; their value can go down as well as up and you may not get back the full amount you put in. Always do your own research and never invest more than you can afford to lose.
Investing is a long-term endeavour. Stock market investing, for example, is only usually recommended if you have at least five years to reach your savings goal.
This is due to the volatile nature of investments, which can go down as well as up in value – even though they generally beat savings account returns over the longer term.
By setting an investment horizon of five years or more, you have more time to ride out any market volatility that could erode the value of your original investment.
So, as a rule, you should only invest money you can afford to live without for at least that amount of time.
Before investing, it’s also important to consider your overall finances. If, for example, you are currently paying interest on credit card debts, it’s probably more sensible to channel any spare cash into paying these off first.
When considering whether to invest, it can be helpful to ask yourself these questions:
How long do you have to reach your savings goal? If you have under five years, a savings account is probably the best option.
Are you willing to risk your money? The value of investments can go up and down, and the highest returns are generally reserved for investors who take on the highest level of risk.
Have you got enough savings to cover any emergencies? An easily accessible emergency fund is an important financial safety net.
Have you got any major life milestones coming up? If you’re nearing retirement, it’s probably not the time to invest in high-risk shares.
Have you got any existing debt that needs to be paid off? Mortgage debt aside, it’s often sensible to clear your debts before starting to invest for the future.
There are lots of different vehicles you can use to invest your money, from a pension to a share dealing account.
The right choice for you will depend on how much you want to invest and over what timeframe, as well as your attitude to risk, your level of knowledge, and how much you’re prepared to pay in fees and charges.
The options available include:
Savings accounts – good for short-term savings and rainy-day funds
Pensions – designed specifically for retirement saving
Investment funds – good for investors who want to leave the trading to a professional fund manager
Share dealing accounts – suit experienced investors seeking flexibility and low fees
A Stocks and Shares ISA allows you to invest up to £20,000 per tax year within a tax-efficient wrapper that protects any returns you make from income tax and capital gains tax (CGT).
There are two main types of Stocks and Shares ISAs:
Managed ISAs: you invest in a fund run by a manager who invests your money in a particular sector or market according to an agreed risk profile and investment aim (capital growth or income)
Self-invested ISAs: you set up a trading account and choose where to invest your money from a range of options including funds, shares, bonds, and investment trusts
The right one for you will depend on your level of investment experience; while beginner investors are usually better off leaving the decision making to a fund manager, knowledgeable investors may prefer to make their own choices.
Either way, the returns you can hope to achieve, and the chances of losing money, will depend on the level of risk you take. While high-risk investments such as start-up companies can provide impressive returns, they are also more likely to fail.
You don’t have to use an ISA wrapper to invest in stocks and shares – although it’s generally a good idea to save tax by using up your ISA allowance each year.
You can also invest in both individual shares and investment funds via an online share dealing platform.
However, you’ll have to pay income tax on any dividends, and CGT on any profits from selling your shares.
This approach is cheap and flexible, but is also high risk and therefore only generally suitable for experienced investors with a thorough understanding of how stock markets work.
There are three main types of share dealing platform to choose between:
Execution-only brokers who act on your instructions to buy or sell shares without offering advice
Advisory brokers who provide advice about which shares you might want to trade but leave the ultimate decisions to you
Discretionary brokers who decide when to buy stocks and shares on your behalf
To start trading, simply open an account with a broker that suits your needs and transfer the funds required to make your first investments.
Pensions are a tax-efficient way of investing because, for every penny you save, the government gives you free cash in the form of tax relief.
Defined Contribution (DC) workplace pensions take advantage of this to grow your savings, and boosting your contributions is an easy way to increase the size of the pot you receive when it’s time to retire – especially if your employer incentivises this by paying in more when you do.
Many schemes will also let you pay in extra money without having to up the contributions from your pay packet. So, if you have savings sitting in the bank, you can funnel them into your workplace pot too.
If you don’t have a workplace pension, or you want more control over how your retirement fund is invested, you can also use a private pension to give you an income when you retire. There are two main types of private pension available:
Personal pension plan: the pension provider invests in funds for you
Self-invested personal pension (SIPP): you choose which funds to invest in
Remember, though, that whatever type of pension you have, you can only access the money you invest in pension funds once you reach the age of 55 (rising to 57 from 2028).
Here is how SIPPs work.
Savings accounts or bonds are a safe place to invest your money, as the actual amount you pay in should never go down.
However, if the rate of return doesn’t beat inflation, which is the case with most savings accounts, your buying power will decrease over time.
Savings accounts are therefore best used short to medium term – say up to five years.
And as with investments, the best type of savings account for you will depend on factors such as how much you want to save, what you are saving for, and how much access you need to your money.
Popular options include:
Instant access accounts – best for emergency funds
Fixed rate bonds – offer higher rates if you tie in a lump sum for an agreed period
Cash ISAs – best for tax-free savings
Regular savings accounts – good for getting into the savings habit
The best way to invest your money will depend on how long you are prepared to forgo access to your savings.
The longer you have to ride out any market volatility, the more risk you can take in the hope of higher returns.
But whatever your timeframe, it’s important to have a diversified portfolio – the investment equivalent of not keeping all your eggs in one basket – and to ensure you’re not paying more than you need in fees and charges that eat into your profits.
As explained above, experts advise against investing your money in the stock market unless you can leave it untouched for at least five years.
The reasoning behind this is that five years is the minimum amount of time you should allow for overall growth to outweigh any losses caused by market volatility.
Investing longer term also allows you to benefit from compound returns, which can further help to negate the impact of negative markets.
Say you earn an annual 2% return on £10,000. In the first year, that will equate to a profit of £200.
But over 10 years, 2% a year will increase the value of your holding by £2,190 if you leave it untouched, meaning reinvesting the annual returns earned you an extra £190.
If you have longer than five years, you might be advised to take on riskier investments that could provide higher returns – at least in the first few years.
As you approach the date you need the money, on the other hand, it’s often sensible to move into less risky investments to avoid any sudden movements slashing the value of your portfolio at that last minute.
Different events affect different companies in different ways. A period of heavy rain, for example, is good for companies that make flood defences, but bad for amusement parks.
So, to reduce the risks associated with investing, it’s important to spread your investments across a range of different sectors and areas.
That way, even if one part of your portfolio is underperforming, this should be offset by another part that is doing well.
Whatever investment approach you choose, you’ll have to pay some kind of fees.
If, for example, you choose to invest via a share dealing account, you’ll need to pay a fee for each trade you make, plus in some cases a monthly platform fee.
And if you invest via a stocks and shares ISA, you’ll usually pay an annual management charge of say 0.25% of your portfolio value, plus the fee charged by the manager of each fund you invest in.
Unsurprisingly, fund managers with strong track records generally command higher fees than their less experienced peers.