I’m sure I’m not alone in thinking ‘wouldn’t it be nice to afford everything you want, be financially independent and even retire early’?.. Unless you’re very lucky and win a big lump sum, saving enough money to allow you to reach your financial dreams takes time and patience.
It wasn’t until 2021 that I started to seriously research finances and investing. There are many success stories out there, which gives you hope that maybe one day you could do it too! But I wanted to share it from a different perspective; someone at the start, trying to make their financial dreams a reality.
Building An Investment Portfolio As A Novice
I want to add before we get started that this is not financial advice and that you should do what’s best for you. Money is a very personal subject and if you are wanting personal advice then speaking to a financial advisor would be most suitable.
Can You Afford To Invest?
The first step in building an investment portfolio is knowing that you can afford to invest. And the easiest way to do that is to budget your money.
Budgeting is the process of balancing your income and expenditure. In other words how much money do you make and how much money do you spend.
'Process of balancing income versus expenditure'
You need to include all sources of income (from a job, dividends, your business..). From this total you need to deduct your expenditure (bills, rent/mortgage, food, childcare, fuel, transport..).
Now you know the answer as to whether you can afford to invest. If you have money spare after deducting all your expenditures then yes you can afford to start investing right away.
However if you can’t then do not worry and take your time. You have two options; either increase your income or reduce your expenditure. By doing this you will have more money left at the end of each month to invest with.
When Should I Start Investing?
Simply put, the sooner you start investing the better! That is all thanks to two ideas; compound interest and inflation.
Inflation is the general progressive increase in services and economy. Essentially it means the cost of living goes up.
Don’t worry, when I first heard all of this my mind was scrambled. So let’s say you have £1, currently that might buy you 4 Freddo frogs, at 25p each. Fast forward 5 years Freddo frogs might cost 50p and that same £1 can only buy you 2. That is inflation and unfortunately you can’t beat it.
Currently inflation is set at 5%. The idea is that if you have £1000 today then in the future that would be the same as owning £950. So if you had a pile of cash and didn’t save it or invest it, that would depreciate in time. If you’re still not sure on inflation, then check out inflation calculators to get a real idea of how it could affect you.
The way to get ahead of inflation is to put your money into things with rates equal to or higher than the rate of inflation. And unfortunately there are none that are risk free. This is where compound interest comes in.
Compound interest basically means that the interest you earn is added to the money you pay in. The next interest calculated will be based off of this total. Essentially it means you earn interest for your interest.
Let’s say you deposit £100 per month for 5 years and earn 7% average annual return, at the end of the 5 years you would have £7200. You have paid in £6000 and received £1200 in compound interest. Not a bad return, right? It beats leaving that £6000 to depreciate in a savings account.
The reason compounding works is because you’re investing in the stock markets longevity. There are ups and downs in the stock market but the overall trend is positive. The sooner you invest the longer you have to ride the wave.
Have a try with some compound interest calculators to figure out how much you could save using this principle (remember to use values representative of what you can afford).
What Are Investments?
By investing in something you are donating some of your resources in order to see growth.
Commonly investing is used to describe contributing money towards a business/ company. That business will use your money to expand/ grow and (hopefully) they become more successful. The money that you initially invested should increase in line with the company’s profit, well that’s the idea.
The reality of investing is actually very risky. There is no guarantee that businesses will succeed and in fact the company could lose value or go completely bust. In other words you lose the money you invested.
What Should I Invest In?
Now this part takes the most time and research. Understanding your options should be a crucial step in your investing journey. Different investments carry different levels of risk and choosing one you feel most comfortable with is important. So I thought I would summarise for you some of the options:
Stocks:
A stock, also known as an equity, is a share ownership in a company.
You buy stocks at share price and this will vary depending on the business and it’s success. The better it does the higher the share price. You can buy stocks through online brokers.
Tip: This option is quite risky therefore know the business that you are investing in. Watch their stock history and look at whether the current stock trend is positive or negative. Read around company’s forecast, whether they are planning to release new products or have a dividend warning- these are all positive signs.
Bonds:
A bond is essentially a loan to a corporation or government. Bonds tend to be less risky because you will get a date in the future where you are guaranteed to be paid your money back and in the mean-time they will pay you interest.
Tip: Bonds tend to be less volatile than stocks therefore if you want something low risk this might be a better option for you. However that tends to mean the rewards aren’t as great as with stocks. It’s a trade off between higher risk but higher earning potential versus lower risk but smaller earning potential. The lower risk means you are more likely to see your initial investment back.
Mutual Funds:
A mutual fund is like a mix of investments. Basically instead of you having to select individual stocks and bonds, you can buy a group in a mutual fund. It’s for this reason mutual funds tend to be less risky than individual stocks.
Let’s say there are 10 companies in your mutual fund and you brought one mutual fund at £100. If one of those companies goes bust, you only lose a small portion of your £100. If you had chosen to invest all £100 in one stock and that went bust, you would have lost all £100! You would have to be very unlucky if all the companies in your mutual fund went bust.
You can either buy into mutual funds owned buy a professional (who chooses companies which have good potential or performance) or buy into index funds. Index funds tend to set parameters such as the 100 top performing companies in a country.
Tip: Usually you need to invest more money into mutual funds and in some cases it might be a condition in the investment. This tends to be because you are investing in a larger group of companies. If you can’t afford to make larger lump sum investments then one alternative is a exchange-traded fund (ETF).
Real Estate Investment Trust (REITS)
REITs allow you to invest in the property sector. Often REITs are involved in commercial real estate, things like shopping centres or office buildings.
Truthfully it is a good way to diversify your portfolio. My parents have always told me you can’t go wrong with property and sure enough if you research property history they tend to appreciate in time, similar to the stock market. It’s for this reason that REITs have also been classed as a low-risk investment.
How Much Should I Invest?
This goes back to my first step of budgeting your money. If you know you have money spare then it’s a potential amount to invest with. Don’t gamble with money you know you need for daily living or maybe in a few month’s needed to repay a debt. If you do have debts work on paying those off first.
The value you chose to invest will depend on your long-term goals and when you want to achieve them.
Many people choose to invest for their retirement. The typical recommendation is to invest 10% of your salary towards retirement. This might sound like a lot but it’s something to work towards.
Let’s say you calculate you have £100 spare at the end of each month, after deducting all your expenditure from your income. The next thing to decide is how risk averse are you. Do you want to deposit some into a savings account and invest the rest, or are you willing to risk it all? This might depend on if you already have some savings to fall back on or if you’re saving for something. It’s a completely personal answer!
How Risky Should I Be?
This will depend on your investment strategy and your saving goals.
If you’re planning on saving for the distant future, say 15 years away, then you might decide to pick a riskier strategy. You have plenty of time to ride the wave and get over the highs and lows that comes with investing.
However if you know you need the money in a years’ time you might want to be more conservative and take a less risky approach.
My Portfolio
Remember that what worked for me might not be the same for you.
I started to invest in my early 20s. I had financial dreams that I wanted to achieve in 10 years time and so I decided that I was comfortable with a riskier approach.
I brought some shares and set up a Vanguard account. Vanguard is an investment platform which caters for many different strategies. There are multiple different investing options available, which means you can be as risky or conservative as you want.
I set up my Vanguard around a year ago and in the past year it has returned 10% interest. Obviously the markets have been extra volatile recently, with the Covid pandemic drastically affecting the stock market.
So far I have withdrawn some money to help me purchase my first home. But now all my efforts are focussed on saving up for the future.
Finally..
The most important part of building your investment portfolio starts with research, knowing what you can afford, deciding your risk level and your saving goals.
Don’t rush into this, the stock market will always be there for you. You should take your time and enjoy the process.
From experience, if you decide to take the plunge and invest, be patient. Investing is a long-game. It won’t happen overnight. But you’ve taken the first step and that’s pretty exciting!