Breaking Down The Investment Choices You Have Once You've Built Up Some Savings

11 mins

Breaking Down The Investment Choices You Have Once You've Built Up Some Savings

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Laying It All Out

If you’ve reached the point where you know you want to invest, rather than just keep your cash in a bank account, you’ll encounter a bewildering number of options. In this pack we’ll walk you through the different places “normal” investors can stick their money in search of a return.

What do you mean “normal”? Well, many governments don’t allow so-called retail investors (average members of the public) to put their savings just anywhere. Places the authorities consider especially risky – like hedge funds and venture capital funds – are only open to sophisticated investors (sometimes called accredited investors in the US). That doesn’t mean top hats, spats and tails… Instead, it’s basically those rich enough to withstand a large financial hit if things go wrong without starving to death.

So where can we mere mortals put our money? The main options are:

  • A traditional fund, which will take investment decisions for you in exchange for an annual fee of roughly 1%-2% of your money.
  • A robo-advisor that uses computers to perform a lot of the basic fund-management tasks more cheaply and charges a fee of maybe 0.4%-0.7%.
  • A “tracker” fund that just follows the movements of a market (the UK’s FTSE 100 stock index, for instance). Usually the lowest-cost choice.
  • Opening an account with a broker and selecting your own investments: for example buying single stocks, gold, or an exchange-traded fund (ETF) tracking US tech shares. You’ll generally be charged for each trade.
  • Getting funky and putting money in an alternative investment: perhaps receiving some shares in return for crowdfunding a smaller company that isn’t listed on public stock markets.

You may have noticed that – as with so much in life – there’s a broad trade-off between service or convenience and fees. And it’s worth remembering that you can (or perhaps even should!) spread your investments across several different places.

In this Pack, we’ll run through these options in more detail.

What else should I bear in mind? Always remember these basic rules of investing:

1️⃣ An investment pays you a return as compensation for the risk of losing money. The higher the return, the higher the risk – almost without exception.

2️⃣ Small differences in annual returns become amplified when compounded over many years. The same goes for fees.

3️⃣ Even if you leave your money in cash, the wicked scourge of inflation will erode its value over time.

4️⃣ Building a balanced portfolio of investments means losses in any one area are more likely to be offset by gains elsewhere.

Make sure you’ve read our Investing Basics pack if all of this is new to you. You won’t regret it.

Alternative Investments

Before we play the mainstream classics, let’s briefly explore the more obscure genres. While most people rightly associate investing with stocks, bonds, and commodities, there are plenty of other investments you can buy in the hope their value will increase.

What are you talking about? Alternative investments is the catch-all name given to a whole load of non-traditional assets. Examples include shares in private (unlisted) companies, lending money to individuals or companies (in return for interest), real estate, and collectibles like fine art or wine. Many also throw the volatile world of cryptocurrencies into this bucket. The thing they all have in common is that they’re generally harder to buy and sell (i.e. they’re less liquid).

What’s the appeal? The main attraction of these alternatives is that their prices don’t tend to react to the same triggers as stocks or bonds – their price movements are often less correlated to economic growth or interest rates, for example. This allows investors to add diversification to their portfolios.

Should I consider them? For an investor just starting out, they’re probably best left well alone. But it’s still good to know some of the options out there.

First up, just as you can buy stock in a company that trades on a public exchange – Apple, for example – it’s also possible to buy tiny stakes in private companies who offer shares on an equity crowdfunding platform – like Wefunder or Crowdcube. This can be a fun way to support your favourite brands, but your money will generally be locked up for a while and difficult to extract again – even if the value of your investment goes up on paper.

Another relatively new option is peer-to-peer (or P2P) lending, where a platform matches your money with people or companies looking to borrow in return for paying interest on the loan. On some platforms you can even fund part of a specific project, like the construction of a new apartment building.

On a more sophisticated vibe, some people like sinking money into luxury goods, in the hope that they’ll climb in value. Who said investing had to be dull! Just remember that storing a classic car or bottle of Bordeaux is a fair bit more expensive than keeping track of stocks and bonds. As with real estate, they can also be expensive – but there are an increasing number of companies out there offering fractional ownership options. Why not check out our pack on Investing in Art for more details?

And what about crypto? 2017’s huge rally in the prices of cryptocurrencies like bitcoin and ethereum attracted a lot of interest in these new digital assets. Sadly, a lot of people got burned in the subsequent crash of 2018. While the underlying blockchain technology is getting bigger every day, investors are still divided over whether cryptocurrencies are the lucrative future of the global economy or just technological snake oil. We offer no judgment – but we do have crypto news in the app if you want to keep on top of developments.

That’s enough alternative rocking for now. Hang up the bass and put away the hair gel: it’s time to get back to the beaten track. These leftfield investments can be fun, but if you’re new to investing you’ll probably want to start with something more straightforward – like a mutual fund, for example, which we’ll talk about next.

Traditional Funds

Back in the days before the internet and smartphones – when Amazon was a river and Netflix something fishermen did at the end of the day – people who wanted to invest in the markets would generally give their cash to a professional fund manager to oversee on their behalf. They would pool lots of small amounts from individual investors into a fund worth many millions (or even billions) of dollars.

These so-called mutual funds are still very much alive and kicking – with more than $40 trillion of assets globally – and remain the most common way for regular joes to invest. Chances are at least part of your pension is invested in some kind of mutual fund.

How do mutual funds work? Investment managers allocate clients’ money to different investments, depending on the fund’s mandate – its mission to focus on things like stocks, bonds, commodities, or a combination thereof. Mutual funds are designed to be long-term investments, and managers aim to generate a decent return each year above and beyond their benchmark (though most fail!). For a fund manager with a mandate to invest in US shares, for example, that benchmark would probably be a broad measure of the entire stock market’s performance, like the S&P 500 index.

How much will they charge me? An average mutual fund will charge you 1%-2% of your money as an annual management fee. There may also be fees for depositing or withdrawing cash. And some funds will pass the cost of trading (broker commissions) onto clients too. Make sure you know what you’re signing up for...

Are there cheaper options? For a lower fee (maybe 0.4%-0.7%) you can put your money in an index fund that just passively follows moves in a market, rather than actively trying to beat that market. Launched in the 1970s, these index funds can keep costs down because they don’t need to employ people to take hands-on investment decisions.

So how do I open a mutual fund? Head to the website of pretty much any fund management company (Fidelity, Legal & General, etc.) and you can open an account. Or you can usually invest in a fund through an individual brokerage account if you have one – in fact, some fund managers insist on it. And be warned that most funds will have a minimum investment amount, so that their admin costs don’t get out of hand.

Mutual funds are highly regulated in most countries, and are obliged to publish key information about their historical performance and investment choices on a regular basis. That makes them quite easy to compare – although past performance is no guide to future returns, and some might argue that picking funds that have had the best recent gains is a bad strategy (because maybe they’re invested in markets whose best days are behind them).

That’s all on traditional fund managers. Next, we’ll talk about mutual funds’ high-tech cousins: robo-advisors.

Robo-Advisors

Robo-advisors are online services that make investment decisions on your behalf. Their goals are the same as traditional fund managers – allocating money to different investments to grow your stash. But because the vast majority of decisions are automated, they have lower staff costs and generally lower fees. Computers don’t need dental plans…

How else are they different? Robos tend to have low minimum investment amounts – great for those with relatively modest savings. And they generally buy and sell exchange-traded funds (ETFs), low-fee investments that track assets, rather than actual stocks or bonds. (See the next session for details of how you can buy ETFs directly if you want to bypass the robos’ management fees.)

How do robos work? Investors define their risk appetite – often by answering questions about their lifestyle and goals – and then a computer algorithm crunches the numbers to create a suitable investment portfolio. If you like to live a little dangerously, the algorithm will put more money in things like stocks. If you’re more cautious, it’ll lean more towards the safety of assets like government bonds.

Confusingly, there’s little or no actual “advice” involved. The robo-advisor will, however, periodically assess the performance of your investments and rebalance funds to maintain your original allocation. If your portfolio was originally 50% stocks and 50% bonds, but after a few months stocks have done well and bonds poorly, the value of your total pot may skew to 55% stocks and 45% bonds. The robo will therefore sell some stocks and buy bonds to bring it back to 50-50.

How much will I have to pay? Annual fees average about 0.25%-0.5% of money invested, versus fees of at least 1% at traditional money managers. On top of the management fee, some robos also charge for adding or withdrawing cash. Worth checking that.

Next, we’ll talk about the flexibility that opening a brokerage account can give you.

Should You Use A Broker?

So far we’ve mainly talked about services that take investment decisions on your behalf. But if you want to wrench control of the steering wheel and head off on your own, then nothing beats the top-down freedom of a cherry-red brokerage account...

What’s that? A broker is your doorway into the markets. They’re the person you contact when you want to buy or sell – whether that’s by mobile app, website, or good old-fashioned telephone. You tell them what you want to trade, and they make the transaction for you. For example, if you wanted to purchase $1,000 of Apple shares, they’d send that request to a stock exchange – where your order to buy Apple would be matched with orders from people looking to sell.

A brokerage account allows you to buy and sell a whole host of assets: stocks in single companies, a variety of bonds both government and corporate, commodities like gold or soybeans – and even exotic financial products like options and other derivatives. You’ll also be able to buy single ETFs (a.k.a. exchange-traded funds).

What’s an ETF? The most popular ETFs track the movements of a market index, making it easy to invest in an entire asset class – from French shares to emerging-market bonds. They’ve become hugely popular because they can be bought and sold exactly like a single stock, even in the middle of the trading day.

Because ETFs generally spread your money more broadly than buying a single stock or bond, they can be a simple way to create a balanced portfolio. Some brokerages – such as Charles Schwab and Vanguard – produce their own ETFs, and sometimes let you trade these own-brand products with zero commission.

What’s commission? That’s the fee the brokerage charges you – and how they make their money. You’ll likely be billed about $5-$10 every time you buy or sell. Some brokerages also charge a monthly or annual admin fee, which might have a certain number of free trades thrown in.

Most brokerages today also offer trading on margin – if they trust your creditworthiness. That means you can borrow the broker’s money in order to pump up the size of your market bets. Though of course this strategy can go horribly wrong...

That’s the end of our Investment Choices pack. Hopefully, we’ve given you a broad overview of the investing landscape, and the confidence to start thinking about which options might be right for you.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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