Understanding the basics of investment

Get your finances on track before contemplating investing

First off, you should ensure that all of your debts are cleared. This means paying off your credit cards, loans and overdrafts – along with any other types of borrowing that you have.

Once you have done this, you can then start to build up your savings.

While everybody should have accessible savings to cater for any short-term emergencies, there is little point in having savings if the interest you are earning is less than the interest you are paying on your debts.

Once your short-term debts are gone, you can then start to look to build cash reserves.

At the same time, you should ensure you have adequate protection in place to protect both you and your family.

This includes policies, such as life insurance, critical illness cover and income protection.

You should check what benefits are provided by your employer, and then look to take out insurance to cover any shortfall. 

Only once you have taken all these steps, will you then be in a position to think about investing.

Read Annie Shaw's guide to common investment mistakes.

Starting to invest

If you are looking to invest for the first time, one of the big dilemmas you will face is whether to invest all of your money in one go – or whether to drip feed it into the stock market over time.

The decision you make can have a big impact on your returns.

You choice is likely to depend on a range of factors, including your personal circumstances, your attitude to risk – and your reasons for wanting to invest.

Lump sum or regular savings

If you are comfortable with the risks associated with investing, and confident about your choices, you may want to invest a lump sum.

But if you are more cautious in your attitude to risk – and nervous about investing at the top of the market – you might prefer to go down the “regular savings” route.

What is investment risk?

Investing a lump sum 

The upside

If, say, you have a sum of £10,000 to invest, this money will have the greatest potential for growth if you put all of it into the stock market right away. This is because the entire investment is immediately fully exposed to the market.

As stocks tend to go up over the long term, fully investing as early as possible means your entire investment is exposed to this upside.

When investing in this way, all of the assets that you buy are bought at the same price. This means that you can benefit from any price increases immediately.

The downside

On the downside, investing using a single amount leaves you vulnerable to buying at the top of the market, and exposed to the potential falls.

The best way to recover from such falls is to remain invested in the stock market over a long period.

That said, this could take considerable time – and requires a lot of nerve and patience.

If stocks and shares are not for you, how about some fun alternative investments?

Investing smaller amounts regularly 

The upside

A good way to smooth out stock market fluctuations over time is by investing smaller amounts on a regular basis.

By making monthly contributions, you can benefit from a strategy known as “pound-cost averaging.”

This effectively means that you buy assets at different prices on a regular basis, rather than buying at just one price. 

This allows you to drip-feed money into the market and, in the long run, should smooth out the bumps and troughs. This can help reduce the effect of market volatility on the value of your investment.

With pound cost averaging, you buy fewer shares when prices are high and more when prices are low. It also means you do not have to worry about deciding when the best time to invest is.

The downside

While there is a chance that regular investing could mean you end up better off than if you had invested a lump sum, you need to be aware that you may not necessarily benefit in this way.

If, for example, you were to pay in a £10,000 lump sum and the stock market rose immediately afterwards, you would get the full benefit of rising share prices. This is because your entire investment is in the market for longer.

By contrast, if you were to drip-feed money into the market, you would miss out on some of that growth.

It is down to you, the investor, to decide which approach is right for you.

Informative, in-depth and in the know: get the latest money news with Saga Magazine.