Investment ISAs put your capital at risk, and you may get back less than you originally invested.
It’s not always easy to decide how to invest money you have to spare. Should you save it, even though interest rates are low and unlikely to beat inflation at current levels? Should you take a gamble and invest it in the stock market? The best place to invest money will generally depend on your financial situation.
In this guide, we explain the different ways you can invest your money to earn a return.
When considering what to do with your savings, you need to understand the difference between saving and investing.
Saving money is when you gradually put money aside over time. You might save up for something you want to buy or do, such as a holiday, a shopping spree or a deposit on a new home. Or you might just save so you have funds for a rainy day, such as the day your car or your boiler breaks down. Most people who save do so using a bank or building society account that pays interest on their savings.
Investing money is when you buy things that you believe will increase in value over time, such as a property or shares in a business. The aim is to make a profit when you come to sell your investments. It’s a gamble and much riskier than saving money into a bank or building society savings account. You could make a lot more money if it goes well but, if it doesn’t, you could make a loss. That’s why you should never invest more than you can afford to lose.
If you don’t have much in the way of savings and you have a lot of debt, taking a gamble by investing probably isn’t right for you. But if you have a sizable nest egg and you’ve cleared most of your debts, you could ringfence a chunk of money to invest.
Savings give you freedom to do what you want, as well as financial security in case something unexpected happens.
Generally, it’s a good idea to have at least three to six months’ worth of living expenses saved up. This should be in a savings account that you can access easily, so that if something happened that meant you couldn’t work, you’d have a three to six-month grace period during which you could continue to pay your mortgage or rent, buy food and so on. It also acts as a useful emergency fund for if something goes wrong in your home.
Saving up 10% of your wages each month is good practice, if you can.
But not everybody should save. If you have bigger priorities to focus on first, namely paying off debts, you should tend to these before you start saving. If you don’t have debts to pay, then you should definitely be saving. If you have no debts but think you will still struggle to save, using a budget planner may help you to see where you can cut costs.
Before you start squirrelling money away or thinking about how to invest money, it’s important that you first clear any outstanding debts you may have.
You’re charged more interest on most credit cards and loans than you can earn on money you pay into a savings account. So use any surplus funds to focus on clearing your debts before you start trying to save.
Here’s what to do:
Start by listing all your outstanding debts
Work out which debt costs you the most
Pay off the debt with the highest interest charges first
Check if there are any restrictions on whether you can repay each debt early, as some fixed term arrangements come with hefty early repayment charges.
It’s a good idea to think about your goals before you make decisions on whether to invest or save. You might base your decision of whether to save or invest on whether your goals are short-term, medium-term or long-term.
the things you plan to do in the next five years. This might involve booking a special holiday or buying a home or car. Money for your short-term goals should go into a savings account. Investing money for a short time period isn’t a good idea as you could make a loss.
the things you plan to do in the next five to 10 years. For savings of this kind, the choice between investments and savings accounts depends largely on how much risk you’re willing to take to get a better return on investment. A savings account involves less risk, but you won’t earn a lot in interest – especially at current rates. Investing is riskier, but should give you better returns.
the things you want to do more than 10 years from now – for example, retiring. For long-term saving, investing your money is often a better choice because you stand to make a bigger profit. While the value of investments such as stocks and shares can go down as well as up, your overall returns should beat those available from a savings account over a longer period.
Below we’ve outlined four options for using your savings. You might want to pick one or two of these or, if you have enough surplus cash, you might want to choose a combination of all four.
It’s a good idea to have at least some funds in a traditional savings account from which you can easily withdraw the cash you need to cover you in an emergency. So look for an account that offers the highest interest rate while giving you the access you need.
If you’re happy to also lock away a lump sum for a set period, a fixed rate bond or notice savings account will often offer a better return than an easy access account.
If you haven’t used your ISA allowance this tax year, it may also be worth opening a Cash ISA or topping up an existing one. For the 2021/22 tax year, the annual ISA allowance is set at £20,000.
The main benefit of an ISA is that you earn interest on your savings without paying tax on the earnings.
Even though basic rate taxpayers can earn up to £1,000 a year in savings interest tax-free (thanks to the Personal Savings Allowance), higher rate taxpayers have a lower limit of £500, and additional rate taxpayers have no Personal Savings Allowance. So an ISA can still be a useful savings vehicle.
Stocks and Shares ISAs (also called Investment ISAs) let you invest your annual ISA allowance in a tax-efficient way and offer an easy way to start investing in the stock market.
They can be used to invest your total allowance – currently £20,000 – or a percentage of it. If you like, you can also split your allowance between a Cash ISA and a Stocks and Shares ISA.
If you’ve still got surplus savings, another option is to use them to reduce the balance on your mortgage. Doing this could save you hundreds or even thousands of pounds in interest.
Some mortgages charge a penalty for you to overpay more than a certain amount each year, so check your mortgage documents or ask your mortgage provider. But most mortgage providers will allow you to overpay up to 10% of the remaining balance per year without incurring a fee.
Even if your lender does charge a fee, it may be worth comparing this with the amount of interest you stand to save by making a large payment.
Depending on your circumstances and existing financial plans for retirement, you could use your money to build a pension fund.
Many consider this the best way to invest money for the long term, as investing or saving into a pension has a number of tax benefits. Depending on your income, these could boost the value of your retirement fund by up to 50%.
Knowing the best way to invest money can be tricky. Investing isn’t a good idea in the short term; it’s a long-term game. But if you’re happy to tie your cash up for at least five years, you could explore your investment options.
Remember that investing means your money is likely to be exposed to some risk. So, even if you choose a low-risk investment, you’ll need to be comfortable with the fact that your money could drop in value if your investments performed badly.
The bigger your investment, the more money you stand to gain – but the more you stand to lose as well.
There are lots of different types of investments. These include:
Stocks and shares
Whatever type of investments you choose, remember that it’s never a good idea to have ‘all your eggs in one basket’.
Diversification, or splitting your money across a range of investments, can therefore be a good way to protect yourself in case one of your investments fails to perform.
If you want to find out more about how best to invest money, it’s probably a good idea to talk to a financial adviser. Professional advice can help you make educated decisions, especially if you’re new to investing.
This investment option lets you set up your own portfolio of shares, or slices of ownership of a given company that are sold to raise capital.
Share dealing lets you buy and sell shares in publicly listed companies using a stocks and shares account. You deal in individual companies' stocks directly.
The idea is to buy shares when their price is low and sell them on when they are worth more. The company sets the initial price, but then it is affected day by day as people buy and sell based on factors such as the economy and the individual company’s performance.
But there are no guarantees. Although you have more control, it can also be a much riskier investment compared to grouped investment methods. So, make sure you know what you are doing before you start.
Investing in precious metals such as gold, platinum, or silver, or in antiques, art or fine wines is increasingly popular. But these are high-risk options.
This means that the value of these types of purchases can fluctuate quickly and you’re at risk of seeing your assets soar and then fall in value in a short time period.
You also don’t get a chance of an ongoing income, and some cost money to store, meaning the only way to profit is to find someone willing to pay more than you did.
Investing in property can allow you to make money in a number of ways, including renting out a house or flat to earn an income and renovating properties to sell them on for a profit.
There are costs to consider, though. If, for example, you rent out the property, you’re taking on the responsibilities and expenses of becoming a landlord, which could end up costing you more than you think.
And if you don’t have the cash to buy a property outright, then you’re likely to need a buy-to-let mortgage.
You may therefore prefer to invest in property by pooling your money with other people in a property investment fund. Real estate investment trusts, for example, can be bought into relatively cheaply, and distribute 90% of the money they make in rents back to investors.
If you’re unsure which option is the best choice for your circumstances, speak to an Independent Financial Adviser (IFA).
An IFA will look at your finances in detail. They will recommend a selection of investment options that are well-suited to your goals and circumstances.
This article is designed to offer you impartial guidance as to your options and what they might mean, but the decision on which product to take out is yours.