Just as the way we work has changed over the last decade, with more of us working ‘remotely’ or in temporary jobs, so the world of saving for our financial future has changed hugely.

We all know we have to save and invest ourselves these days, but many of us just don’t know how to do it or even where to begin.

With our weekly First Time Investor series we will take you through the basics of how to start thinking about long-term investing, how to get the most out of your investments and how to secure your financial future.

INVESTING CAN BE FOR EVERYONE

Lots of people assume investing isn’t for them, that it is somehow the preserve of the incredibly wealthy or people at a certain stage of life. That simply isn’t true, investing can be a good option for almost anyone given the range of options available.

Don’t be put off by the fear of looking foolish and by the often needless and confounding jargon, even the most experienced investor was once sat where you are now – everybody has to start somewhere.

For an investor the markets are simply a tool with two main uses: to protect and increase your wealth. If you can train yourself to think in these terms, then any fears you have about investing should diminish.

DIY INVESTING

Today most firms have stopped offering new employees a defined benefit pension scheme – funded by a company and paying out a secure income for life when you retire.

Instead they offer a defined contribution scheme, which pays an income depending on the amount you yourself pay in, the performance of your investment ‘pot’ and the choices you make when you finish working.

On top of this, the high street banks have pulled back from offering advice on how to invest your money – mainly because they have been so bad at doing it, as shown by various mis-selling scandals.

The result is we are all now responsible for planning our long-term financial future in a way we weren’t even a few short years ago.

What has also become clear is that many of us aren’t saving or investing enough to provide a reasonable standard of living in retirement.

This is where Shares can help. Over the next few weeks and months we will explain the basics of investing, why investing can be better than saving and why starting early matters.

We’ll also look at how to invest for specific goals like saving for a first home or a first child, or for longer-term goals like university fees.

Even with a small amount of time and money, following our step-by-step guide will help you to start planning for the future.

SAVING IS A GOOD START

Most of us have a savings account as well as a current account, and these days with the range of accounts available from smaller disruptors like Monzo and Revolut some of us have more than one ‘secondary’ account.

However the rates of interest on most savings accounts are typically below the rate of inflation, meaning that in real terms your savings aren’t keeping up with the cost of living.

For example, according to Moneysavingexpert.com, the best easy-access online savings accounts currently pay an annual rate of interest of between 1.3% and 1.35%. So for every £1,000 saved you would only earn between £13 and £13.50 over the course of a year.

Interest on savings accounts is tax-free for most people. Basic-rate tax-payers can earn £1,000 in interest a year free of tax while for higher-rate tax-payers the limit is £500, so only people with large amounts of savings would need to worry about paying tax on interest earned.

However, the official rate of inflation as measured by the consumer price index (CPI) is 1.4% as costs for housing, water, electricity and gas aren’t going down. With the economy starting to pick up after the general election, prices might even rise further this year.

If you want a higher rate of interest you’ll have to stick your money away for a fixed period, say up to three years. For that you get 2% interest but you can’t access your money in the meantime. Also, 2% is lower than some banks were offering a year ago for just a one-year fixed deposit of £1,000 or more which shows how far interest rates have fallen.

A savings account is probably most appropriate as a place to keep money to cover unexpected expenses like a replacement washing machine or periods out of employment.

INVESTING IS BETTER

If you’ve already built up these emergency funds and you want your money to earn a better return than it will in the bank, the case for investing is compelling. Over the very long term – more than 100 years – annual returns from the UK stock market have been roughly 5% above the average rate of inflation according to the Equity Gilt Study published every year by Barclays (BARC).

Over the same period the annual return on UK government bonds, also known as gilts, has been 1.3% above the rate of inflation while the return on cash has been just 0.7% above inflation on average.

On a 10 year view the returns on stocks and bonds have been even better at 5.8% and 2.7% above inflation, but the returns on cash have been much worse at 2.5% below the rate of inflation. This shows that leaving your cash in your savings account isn’t going to help fund your old age or any big life goals as it will just lose value in real terms.

COMPOUND INTEREST

Let us assume that, instead of your money earning 1.3% or even 2% in a savings account, you invested £1,000, which at around £80 per month is not too far away from the cost of a gym membership or TV subscription.

On the reasonable assumption that you were were earning 5.8% more than the inflation rate over 10 years – let’s say 7.3% a year, assuming inflation averaged 1.5% a year – you would have ended up with £73 in returns after the first year.

What’s more, if you kept that £73 in the markets so you now had £1,073 in capital, a year later your return at 7.3% would be £78 because your starting capital was higher. Adding that £78 to the £1,073 means you start the third year with £1,151 and your return rises to £84.

This is called compounding, because each year you are earning returns on what you got last year as well as your initial capital, your money is working harder for you. The higher the rate of return, the faster your investment compounds and the harder your money is working.

The table below shows how your money would compound over 10 years assuming an annual return of 7.3%.

What the table shows is that by leaving your capital and returns invested, the amount you make annually on your money goes from £73 to start with to more than £500 by the end of six years and more than £1,000 over the full 10 years.

Also, by adding the returns to the capital each year and letting it compound, £1,000 a year turns into more than £6,000 after just five years, getting on for £10,000 after just seven years and more than £15,000 over the full 10 years. Potentially providing a good starting point for a deposit on a house, for example.

This is just an indicative example and doesn’t take into account investment fees, which will affect your returns, although shares offer not just the potential for capital appreciation from price increases but also regular income from dividend payments. By reinvesting these regular payments in more shares you can super charge your returns because, as you increase your holdings of a particular stock or fund, you also boost the amount of dividend income you receive, with the level of payment dependent on the number of shares or fund units you own.

We will cover dividend reinvestment in more detail in a future article in this series.

Overall it is little wonder Albert Einstein described the effect of compounding as ‘the most powerful force in the universe’, and it’s a crucial first lesson on the way to long-term investing.

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