Many people believe that cash is a safe way of saving, but when it comes to the long term, cash is not king. Over the past two decades average UK savings rates have been going one way – down. Since about 2012, average interest on cash savings have been about 2% a year or less.

This decline could be managed during the years of low inflation but emerging from the pandemic has turned all that on its head. With the cost-of-living rising sharply since 2021, cash stashed away has been losing value hand over fist. True, average savings rates have also been rising, but the calculus of rough 10% inflation versus the 5% to 6% you can get on your savings means their ‘real’ buying power is roughly halving each year.

Savers should consider unlocking the long-term investors in themselves by being proactive with their finances and embracing the opportunities available on stock markets. This is where a Stocks and Shares ISA, sometimes called an Investment ISA, can help, giving you the potential for better returns that could help you beat inflation. ISA stands for Individual Savings Account.

You might worry about the challenges of investing, and it can appear daunting for those starting out. It can seem very complex and confusing. The value of any investment can go down as well as up, so you might end up losing money rather than saving it. Research by Legal & General (LGEN) shows that 18% of new investors fear making the wrong investment decisions.

‘Knowing where to start is hard – especially in turbulent times,’ says Lorna Shah, managing director of Legal & General Retail Retirement. ‘People will understandably be feeling unsure about the future at this moment in time.’

But she goes on to make a reassuring point: ‘The key thing to remember is that investing is for the long term. With time on your side, you can potentially balance out the ups and downs of the market.’

A century of data from the Barclays Equity Gilt Study shows that on average, stock markets have provided a total return to investors of about 6% a year, and that’s after factoring in the effects of inflation. Doesn’t sound much? Just look at the example in the table.

In practice, you should not expect a smooth journey. Stock markets move up and down all the time, so rather than getting 6% every year you’re more likely to see a more volatile pattern; 12% up one year, 5% down another year, 3% up, 7% down, 16% up, 9% down and so on.

COVERING THE BASICS

Stocks and shares are units of ownership in a company. Companies sell them to shareholders to provide funding to grow their business. Some companies have millions of shareholders, who all own a tiny piece of the company; others have just a handful. People buy and sell shares on stock markets like the London Stock Exchange (LSE).

How stocks and shares can beat inflation

There are two ways for shareholders to ‘earn’ money:

– Selling their shares for a higher price than they paid for them (also known as a capital gain);

– Holding onto their shares in return for a payment from the company, known as a dividend.

That can create a return that’s higher than the rate of inflation, which is how the right investment can help you beat rising prices.

If there are concerns about the company’s growth or performance and demand for shares is low, the value of your shares will go down and you may get back less than you invested. There’s no guarantee on dividends either.

In a poor year, the directors may decide there isn’t enough surplus cash available from the business to pay shareholders what they were expecting, or any dividend at all. But it is important to remember, over the long term, dividends and share prices are likely to produce something close to their long-term averages.

There are three ways to invest in the stock market. You can:

– Choose the individual shares yourself;

– Employ an expert to choose the shares for you which can be prohibitively expensive if you are only investing relatively modest sums;

– Invest through an investment fund, where a fund manager chooses the shares on behalf of all the investors in the fund.

For example, investment platform AJ Bell (AJB) offers a selection of ready-made portfolios, hand-picked by its own investment experts, designed to suit anyone.

If you are a very careful person who wants to limit risks as much as possible, there’s a Cautious ready-made portfolio. Similarly, when you are younger and have a longer investment horizon, there’s an Adventurous option, or a Balanced portfolio which sits between the two. There’s also an Income ready-made portfolio, which typically suits those already in retirement.

There’s plenty to consider if you’re new to investing, such as:

– How high to set your budget;

– How long you’re likely to be investing;

– Your attitude to risk;

– How much you’re willing to lose if things don’t work out.

ASSESSING RISK

No single asset class can be relied on to always produce safe, reliable and consistent returns, which is why diversification is so important. Bonds and cash are likely to have lower returns than company shares but tend to remain more stable.

As a rule of thumb, for a better chance of higher returns, consider investing more in shares in your Stocks and Shares ISA. If you want steady growth, consider more bonds. For low risk but more modest returns, hold cash in a Cash ISA. For most people starting out funds are a more logical choice than individual shares.

A Stocks and Shares ISA is a simple, easy-to-use investment product, it shields any capital gains and income from your investments from HMRC and means you avoid the hassle of having to fill in a tax return. This article offers a run through of the different types of ISA and their pros and cons. 

Like any investment, the value could fall as well as rise and isn’t guaranteed. You may get back less than you invest, especially over a shorter period, which is why it is so important to maintain that long-term mindset.

GETTING THE BALL ROLLING

Importantly, you don’t need a large lump sum to start investing with a Stocks and Shares ISA, some will allow you to invest as little as £100 to get started, or £25 per month and will enable you to invest in thousands of stocks, like Tesla (TSLA:NASDAQ), Tesco (TSCO) or Netflix (NFLX:NASDAQ), over 2,000 funds and more than 450 investment trusts.

The more you contribute, the more you could see in return. But remember, with higher potential returns comes more uncertainty, so you should make sure you select the risk level that works best for you.

Every provider sets their own fees and these will often cover managing your funds and will also depend on whether you have chosen to use a financial adviser.

‘How much your account costs depends on whether you hold funds or shares, and how frequently you deal,’ says Russ Mould of AJ Bell. ‘When you buy or sell an investment, you’ll pay a dealing charge. You’ll also pay a custody charge for holding an investment. Dealing and custody charges differ for funds and shares.’

AJ Bell, like other ISA providers, offers a handy calculator that can help work out your overall charges. The platform will also send you an annual costs and charges statement, so you’ll always be informed of what your ISA is costing to run.

You can put money into a combination of ISAs with different providers if you don’t invest more than the ISA annual allowance, currently £20,000 a year, and open more than one of each per tax year.

To allay any fears try to think about it like this.The financial markets are just a tool to help you generate wealth and an ISA is one of the best ways of accessing them.

Start by investing £5 per day to make a million

Let’s say you start investing £5 a day in UK stocks when you are 25. That’s the equivalent of £1,825 a year.

If you carried on doing that for 43 years, you would have £452,192 by the time you reached your expected retirement age of 68. If you were even more sensible and increased your contributions by 5% every year, you would have £993,194 to retire on. That’s just shy of a million.

These figures assume you enjoy an average total return of 7% a year, which is roughly the long-term return of the FTSE 100. So, it’s doable, but with one big proviso. To make £1 million from investing £5 a day in UK stocks, it’s important to start early.

An investor with a shorter timescale could still do it, but they’d have to generate a higher average return than 7% a year, which would involve taking on higher risks. That of course increases the danger that something will go wrong. Otherwise, they could pay in more.

If you were 45 years old and wanted to make £1 million from UK stocks starting from scratch, investing £5 a day and adding 5% a year wouldn’t do it. Incredibly, you would have to start by investing the equivalent of £30 a day, or £10,950 a year, which is six times as much.

If you increased that sum by 5% a year you could possibly build a retirement pot of £974,350 over the 23 years at your disposal.

However, just because you’ve left it later than would have been ideal does not mean you shouldn’t start now. You can still make a tangible difference to your standard of living in retirement or save up cash for your kids’ education, home improvements or any other investment goal you might have.

Note: These are just indicative examples and do not take into account any fee or charges.

ETFS TO GET YOU STARTED

Exchange-traded funds are low-cost funds which trade on the stock market in the same way as shares. They are a good starting point for a novice as they enable you to get broad-based exposure to a range of markets and asset classes. Below are some suggestions to help you build your first ISA portfolio.

ETFs like other types of fund usually come with income or inc versions, which pay out dividends, and accumulation or acc versions which reinvest them for you automatically. We’ve include the acc versions because they are probably better suited for someone investing for the long term who doesn’t need the income today.

ISHARES CORE FTSE 100 ETF (CUKX) £143.98

Even those who are new to investing should have heard of the FTSE 100. It frequently appears on TV news bulletins and in the newspapers, with its direction up or down giving the public a steer as to how the stock market is performing.

The index, a representation of the UK’s 100 largest companies by market value, is packed full of names well-known to the public, like
BT (BT.A), Barclays (BARC), Shell (SHEL) and Vodafone (VOD).

For any investor, having some exposure to the UK’s largest companies has logic, and many in the investment world currently think the UK stock market represents better value for money right now than the US S&P 500 and Nasdaq.

The FTSE 100 is currently trading on a 12-month forward price-to-earnings (PE) ratio of 12.5-times, according to Stockopedia, compared to a PE of 18.1 for the S&P 500 and 14.6 for the Nasdaq Composite.

The iShares ETF is one of the most popular ETFs which track the FTSE 100 index, and with a total cost of 0.07% a year is a very cost effective method of gaining exposure to the largest companies listed on the UK market. We’ve included the accumulating version here but investors put off by the relatively high cost of individual units could buy the income version which has the ticker ‘ISF’ and a price of 775p.

LYXOR CORE MSCI WORLD ETF (LCWL) £11.69

Providing exposure to 1,601 companies across 23 developed market countries, the MSCI World index is as about as broad and comprehensive an investment as you can get.

With more than two thirds of the index made up of businesses in the US, this is the part of your portfolio where you will feel the benefit of exposure to faster growth businesses that tend to list in the US, such as technology giants like Microsoft (MSFT:NASDAQ), Amazon (AMZN:NASDAQ) and Google-owner Alphabet (GOOG:NASDAQ), though also still getting the benefit from diversification with access to other developed market economies like Japan and the Eurozone.

A low cost way to track this index is Lyxor Core MSCI WORLD, which has ongoing charges of 0.12% a year.

Given the sheer size of the MSCI World index, this ETF buys a carefully selected sample of the stocks in the index to mimic its risk and return profile, as well as maintain liquidity and keep transactions costs low, pushing its total cost of ownership lower than many other ETFs which also track the index.

ISHARES CORE MSCI EM IMI ETF (EMIM) £24.23

Given they’re part of some of the fastest growing economies on earth, having exposure to stocks in your starter portfolio from emerging market (EM) countries is a good idea. There are risks with these markets, as their name suggests they are still ‘emerging’ and can frequently encounter teething problems as they develop, and so should only make up a small part of a portfolio for a beginner investor or someone who doesn’t have the time to regularly monitor their investments.

But EM companies are still worth including for their growth potential and supportive demographic trends. A great way to do this is through iShares Core MSCI EM IMI (EMIM), which tracks the MSCI Emerging Markets Investable Markets index and is the cheapest option to do so with an 0.18% a year ongoing charge. It’s also one of the popular ETFs tracking this space globally with responsibility for over $15 billion of investors’ money.

This ETF offers exposure to the China growth story, while also getting the benefit of diversification to other markets like South Korea, India and Taiwan.

Leading companies in the ETF include Alibaba (BABA:NYSE) and Tencent (0700:HK), plus South Korean electronics conglomerate Samsung (005930:KS).

ISHARES CORE UK GILTS ETF (IGLT) £10.40

UK government bonds, known as gilts, are a useful if dull addition to a sensible starter portfolio. Government bonds, especially
those issued by developed market governments like the UK, are seen as a safe haven in times of uncertainty. This is because they are considered very unlikely to default on their debts.

The best way to invest in gilts is through an ETF. The world of active fund management has practically given up on trying to add value through gilts, given years of low interest rates, and this iShares ETF is a one of the cheapest around, with a cost of 0.07% a year. It is also very liquid with £1.6 billion in assets and has generally exhibited a low level of volatility.

DISCLAIMER: Financial services company AJ Bell referenced in this article owns Shares magazine. The author of this article (Steven Frazer) and the editor (Tom Sieber) own shares
in AJ Bell.

‹ Previous2023-03-02Next ›