Asset building with index-trackers
We’re now into week 5 of the 7-week budget series. I have been working through a method of budgeting that gives you ways to split your well-earned money up so that EVERY amount you spend has a purpose, but WITHOUT making you feel restricted.
So far we have had:
This week I am going to write about investing. If you are part of a pension plan, then you already do this! It might sound strange to consider yourself an investor, but its true! You are!
The money you pay into the pension every month goes into a fund which is invested on the stock market. This enables the money to grow, and in theory, as you and your employer keep adding more, eventually your money should appreciate to the point where you’ll be able to retire. I have an e-book that summaries ideas for retirement for you that you can access here if you want to look at your options, but today, I want to talk about a few quick ways you can get started now, and some of what I do to invest.
Pay yourself first
Your investing “slice” is also known as “pay yourself first”, and you should be aiming for 10% of your well-earned money per month. Pay yourself first is a concept that means you ensure you always have money to invest above anything else in your budget. It took me a while to get my head round it, because I never seemed to have any money left over to use, but when I realised what having assets meant, and that by tweaking my essentials budget, I could release money to invest, I got it, and now I wouldn’t sacrifice investing for anything.
I can’t cover everything to do with investing in this post (not to mention the fact that there are people out there who are waaaaaay more knowledgeable than me at it!), but at the end of it, I’ll put in a few resources you can refer to, in addition to a website post of a fellow money blogger that gives you other types of investing that you may want to explore.
If the idea of investing on the stock market gives you the heebee-jeebies, then don’t worry! I’m going to do my best to tell you how I do this, and I have also produced a list of “rules” to adhere to if/when you start doing this by yourself.
So here goes!
My favourite type of investing is “passive” investing with low-cost index trackers on a monthly basis.
There are many reasons for this, but mainly I love them because they are so EASY to start with from just £25 per month – the cost of 5 x £5 lunches at work!!
When people think of investing, they think of “trading” – where you have an angry looking stock-broker jumping up and down, buying and selling stocks, with plenty of swearing and chest bumping in equal measure(!) This kind of investing is exhausting and extremely off-putting to the majority of us, plus you are buying and selling stock of individual businesses at a time. This puts your money at risk, because if the company goes bust, you can kiss bye-bye to your stocks… and your money.
Index trackers are types of funds that pull together a little bit of a lot of businesses, hereby satisfying #4 of “the rules”.
It is NOT trading, nor is it a gimmicky “get rich quick” scheme.
So for example, the HSBC FTSE 100 would be a fund of the top 100 “blue chip” (large, well-established businesses) companies in the UK stock exchange (the Financial Times Stock Exchange). There will be an equivalent in your own country if you’re not from the UK, so take a look on google for “index trackers” or “exchange traded funds” in your country. Please note, exchange traded funds are a bit different, but they are low cost too. I won’t go into this today, but I’ll aim to go over this in the future.
How well do tracker funds perform?
The FTSE 100 tracker fund to give an example, returns on average 5.5% per annum vs. a savings account which may initially give you 5% for the first 12 months, but then will drop down to much less, meaning you must move your money around to take advantage of all the rates on offer!
It may seem safer to leave money in a savings account, but with inflation of money over time, the £10,000 you have in 2017 will be worth far less in 2037. Don’t believe that? Think about how much £100 bought you in 1900, vs. 2000…..you certainly wouldn’t get the country manor on that kind of budget today!
Money in the stock market does go up, but it also goes down. In times of large financial crises, this can be by quite a significant amount. But if you stick to “the rules”, you’ll be much less likely to be damaged long-term from any dips. Time in the market fixes most drops, so the longer you leave the money in, the better the recovery you’ll have.
There is one caveat to this – if you a nearing retirement age, you may wish to consider transferring a lot of the stocks into more stable bonds, so the market fluctuations don’t hit you so badly. I would certainly seek professional advice on this.
How I use Index Trackers
So now to get a bit more nitty-gritty with the process!
The way I invest is by putting a steady amount into an online investment platform. I chose Hargreaves Lansdown because its easy to use, and allows me to add on lots of different types of accounts in one place (it means I only have to use one password!). Hargreaves Lansdown would be the equivalent of your bank or building society because it houses all of your accounts much in the same way a bank does.
Please note, I do not have any financial incentive to recommend Hargreaves Lansdown – it is simply the platform that I use that I am comfortable with!
The first account I opened was a stocks and shares ISA (which is tax-free). The reason I opened this was because the money that the stocks create for me over time will also be tax free. This is an awesome thing, especially when it comes to withdrawal one day!
The ISA would be the equivalent of an account that you would open within your bank (if we continue with the analogy). Within the Hargreaves Lansdown platform (“The Bank”), you can have a variety of accounts within it that have different purposes and benefits. I’ll do a post at some point about all the different options, but it will be too overwhelming here!
How I pick the funds
Once I had opened my ISA, I started putting £25 per month into the account to purchase a low-cost index tracker. These are trackers that have very low ongoing charges (<0.5%), and no fund manager looking after them. I chose the HSBC FTSE 250. This is not a recommendation of what you should invest in, but when you start looking, start with your own country first (or if you live in a country with an unstable economy, then pick a country with a stable economy to get started). Hargreaves Lansdown has a useful guide of what they would recommend here. Check out the funds with little purple stars next to them, and you’ll see that they are low-cost trackers that they recommend.
Always read the additional information that comes with the fund before you set up the direct debit. It will tell you which businesses the money will be going towards, how the fund has performed in the past, and what the charges are. The ongoing charges (or total expense ratio) is the most important charge to look at. Good past performance doesn’t guarantee that it will continue in the same way in the future, but ones that have been established for longer may make you feel more confident.
The final thing to do is to pick the accumulation type of the fund. This means that the gains your money makes gets automatically put back into the fund to grow your money even more.
If all this leaves you nauseas, but you really want to start investing, you could try an app. Believe it or not, but your phone can now help you invest! I’ve recently tried moneybox, which is an app that, among many options, rounds up all your transactions to the nearest pound and saves it for you ready to invest. I’ve started experimenting with it to see how it compares with my stocks and shares account online. Its really simple to download and install, but you have to be comfortable with allowing the app to have access to your bank account. Moneybox has bank-grade security AND is covered by the Financial Services Compensation Scheme (FSCS) up to a value of £50,000, which is very reassuring!
You can set the risk level that you feel comfortable with such as cautious, balanced and adventurous.
The issue I have with this app though is the fees. Its free for the first 3 months, but then after that you are charged £1 per month. You also pay 0.45% in platform fees (of the value of your investments) per year, and 0.22%-0.24% fund manager fee. This may seem harmless, but its much cheaper when you purchase low-cost index trackers on a platform like Hargreaves Lansdown. Small differences really do add up, and could end up costing you thousands in the long run.
However, if you really hate the idea of learning how to invest, then I think this has real potential. Points are lost unfortunately for the cost that you pay to use the service, but its better than leaving it sitting in a bank account doing nothing.
I’ll let you know more of my thoughts on it once I have used it for a few months, so watch this space!
A word on financial planners and advisers
Some people like to get a financial adviser to sort their investments out for them. This isn’t fundamentally a bad thing, but remember these individuals are providing a service that you are paying for which runs the risk of conflicts of interest. This may be via higher annual charges than by learning to do this yourself. The more you can educate yourself, the easier it is for you to question your financial adviser to ensure your money is being well invested. They may be very useful when it comes to investing large sums of money, and I would encourage you to seek advice in this case, but do your research: get recommendations, ensure the person has a decent portfolio of their own, and don’t fully give up your power!
So that’s it, this is a MEGA post! I hope it has given you a bit more confidence to look at stocks and shares for yourself. Honestly, if I can do it, you can too. And from £25 per month, can you afford not to?
Good luck, and let me know how you get on! Whatever you decide to do, aim to set aside 10% every month for asset building. You’ll be far better off financially if you do, and that retirement you have planned is far more likely to happen!
Other resources you will enjoy!
Post from frugalstudent.co.uk regarding other types of investment strategies – http://www.frugalstudent.co.uk/index.php/investment-strategies-explained/
“The Rules” I have pulled together from different resources and learning from experts! Back up
- The bulk of your cash should be spent on paying off consumer debt if you have it. BUT you must dedicate some money to investing to train yourself into the habit of “paying yourself first” AND to get yourself in the market. Time is of the essence. Once your debt is paid – you’ll have loads more to invest.
- Leave your emotions out of it. Investing emotionally is a sure-fire way to fail. Investments should be numbers driven only. So don’t be emotional! Yes, the stock market goes down, but it will always go up! If you have a well-diversified portfolio, you have nothing to fear. Leave your investments alone, and take advantage of dips in the market – that’s when the sales are on!
- Check your investments rarely. There is no point in checking your investments too often. Once a month is the limit. Even then, you’re not authorised to do anything for at least 1 year in the market!
- Keep your investments well spread around – country, sector and type ideally, but if you’re just starting out, an index tracker is a PERFECT starter for diversification.
- Investments are for the long haul. There is no point investing for only a year. Investments need time to recover when they did. Look to invest for at least 5 years, but ideally for life. You can release the money in stages when you need it later and still leave money in to keep growing. That’s how you make a sustainable retirement fund.
- DO NOT TAKE MONEY OUT! Once the money is in your investment, you are not allowed to take it out. Make sure you only invest what you don’t need every month (but don’t make this an excuse NOT to invest).
- Use up all your tax-free accounts first. In the UK, this would be an ISA. In 2017/2018 you get £20,000 for the whole year. Your goal is to fill this up as much as possible, because everything held within the ISA grows TAX-FREE. What if you already have a cash ISA? No worries – you can transfer if into a stocks and shares version very easily.
- Take advantage of pound-cost averaging. Save the same amount every month, and you get to take advantage of this phenomenon. Lets say you have £100 to invest every month in a particular stock. Some months your £100 buys more of it, and sometimes it buys less depending on how the market is doing. If you buy £1000 in stocks in one go, and don’t spread it around, then you don’t get to take advantage of when the market drops. Drip feeding into your investments is a smart way to make your money go further!
- Choose accumulation options every time for growth. This means that anything you make from the investment is reinvested automatically, making your money grow further!
- Keep ongoing changes below 1%. Ideally you can keep it way below 0.5%, so make sure you shop around