Paying off unsecured debt, building a six-month emergency fund, maximising pension contributions, and then opening a Stocks and Shares ISA often constitute the typical initial steps.
The covid-19 pandemic, like all major medical disasters, came with some silver linings. For the first time, individuals experienced a world without major traffic, without needing to go to work, and with far more free time than ever before.
In addition, a combination of personal financial support from governments worldwide, and the meme stock craze of early 2021, combined to see millions of people have both the excess discretionary income, and the inclination, to dip their toes into the world of investing.
According to the ONS, because of rocketing house prices, forced savings, and the equities and crypto bull run, households accumulated £140 billion of additional savings during the pandemic.
But many who didn’t know how to trade highly speculative penny stocks lost their money as fast as they received it.
And while this article is not investment advice, it can give a few helpful pointers on how one can start investing without first enduring a baptism of fire.
5 Steps to Start Investing
Pay off all debt, excluding mortgage debt which for most would be impractical and for all usually comes with steep fees.
The average UK credit card debt stands at £2,230, with an average interest rate of circa 20%. Few investors can beat a guaranteed 20% return, so paying off any unsecured debt first makes sense, especially as it means you are less likely to need to cash in investments in the downturn when they may be worth less than when you started investing.
According to Moneyfacts, the average UK two-year mortgage fix is now at 6.5%, so overpaying on your mortgage, which can be usually done fee-free to the tune of 10% more per month, is also looking more attractive than in the past.
2) Emergency Fund
Building up an emergency fund is essential in a bear market, and doubly so for UK investors. Energy bills are set to skyrocket to over £4,000 per year in April, while the typical monthly mortgage payment has risen by over £500 and could well rise further the more the Bank of England increases the base rate.
With CPI inflation at 10.1% and rising, it now makes sense to have six months of expenses saved up, usually in premium bonds, or within an easy access savings account, many of which now pay competitive interest.
This an important step because the UK could be in for a long, severe recession. The pandemic recovery, Ukraine War, rising bills, and supply chain problems could combine with the new PM’s strict fiscal policy to create a toxic cocktail of job losses and corporate closures sooner than many expect.
What’s critical is that investors avoid realising a loss after buying stocks in a bear market. It’s perfectly possible, and even very common, to invest in a solid blue chip like Alphabet, which has fallen by over third year-to-date, only for it to fall another third before recovering to new heights.
And it’s worth noting that timing the market low is almost impossible; the pandemic crash lasted a few weeks, the 2008 credit crunch roughly five quarters, and previous crashes have lasted for years.
3) Government and corporate contributions
Two important things to consider here. Salary sacrifice into your workplace pension, which is topped up by both the government and your employer, is incredibly tax efficient. So too is contributing to a private pension like a SIPP, with key advantages in depth here.
In addition, for those aged under 40, the Lifetime ISA provides an excellent return until age 50, with the government topping up £4,000 of savings per year with £1,000 (or 20%) tax free. However, this money can only be spent on a first home or withdrawn at age 60.
Of course, this return can be beaten by SIPP contributions, so the Lifetime ISA is not suitable for all investors. But the most important disadvantage of both is that you cannot withdraw money saved in either without tanking a huge financial penalty.
4) Open a Stocks and Shares ISA
UK retail investors can invest up to £20,000 per year into their combined ISA (individual savings account) portfolio, including the £4,000 in their Lifetime ISA.
If you have more than £20,000pa in excess income to invest, then an Independent Financial Adviser (IFA) may be in order.
The key advantage is that all returns, including capital gains and dividend income, are tax-free. This advantage is unlimited, so that an initial investment made in your early 20s can easily quadruple by retirement through the magic of compound interest with no tax due whatsoever.
New investors often choose to invest in two popular Exchange Traded Funds (ETFs), a FTSE 100 ETF and an S&P 500 ETF. The oil and bank heavy FTSE 100 stocks provide dividend income during times of economic stress, while the S&P 500’s tech sector growth stocks provide outsized gains when times are good.
5) Learn and Diversify
Once an investor starts getting comfortable, it’s then time to make use of the hundreds of free investing education tools available online (though be careful to seek a reputable and impartial source of information). Assess your risk tolerance, how much you can afford to invest each month, and which areas of investing interest you.
One key lesson is diversification. A highly diversified portfolio usually carries less risk and better returns over the longer term, and includes assets like high-growth penny shares, commodities, fixed income, and cryptocurrency.
A second is learning to hold quality assets despite paper losses. This can be psychologically far harder than it sounds.
Once confident, leveraged trading through CFDs or spread betting can be lucrative, though typically more investors lose money on these types of trades than gain.
However, you need to weigh the guaranteed 5% interest return on top savings accounts against the higher risks of investing. Ultimately, the returns can be far, far higher, but the risks are of course correspondingly magnified.
This article has been prepared for information purposes only by Charles Archer. It does not constitute advice, and no party accepts any liability for either accuracy or for investing decisions made using the information provided.
Further, it is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.