Investing – where to start and where to end up
What you want your savings for – and as importantly when – are prime considerations for the investor
Article by Tom Anderson
A good place to start investing is to identify your objective. This means working out what you’re trying to achieve in honest, numerical terms… if you want to save towards a deposit; how much and when? If you want to generate an income in retirement, again; how much do you want to live off when you retire and how many years off is that?
Once you have decided the number that you’re aiming for, you can work out what return you need to do to get there. Let’s say that you’re 30 now and want to retire at 60 with an income of £40,000; what do you need as capital to generate this income?
If you were to start with £20,000 and add £1,000 each month, this would get to £380,000 after 30 years. This sounds like a decent amount, but if you decide that you will need an income of £40,000 each year then your carefully-hoarded cash would be gone in less than a decade so we need to increase the return. If you were to put these same contributions into a bank with interest at 0.5 per cent each year, you would get to £411,000. This is a slight improvement but a return of 0.5 per cent of £400,000 gives you an annual income of £2,000 which is clearly not enough to live off.
The “4 per cent rule” would suggest you need the daunting sum of £1m to provide this level of income at current market levels. However, a £1 million figure is not as unassailable as it might initially seem. To achieve this, your initial lump sum of £20,000 and your £1,000 monthly additions need to grow at least 5 per cent each year. The question is; where can you get a return that is in any way close to that?
The inevitable answer is that you will need to start taking more risk to try to earn the associated reward. These more risky assets could include property, interest-paying bonds (also called debt) or equity (‘stocks and shares’). Of these, you may be surprised to hear that equity – owning shares in a company – has actually performed better than the others over long periods of time with an annualised net return of 5.5 per cent despite the volatility and risk.
This volatility should not be dismissed lightly. Equity markets have lost up to 50 per cent of their value at various points over the last 30 years and an investment portfolio with a holding of equity would not be immune from these falls. However, we will need to harness these markets to provide the driving power behind that urgently-required plus five per cent return that will one day allow us to stop working completely or disengage from the rat-race in our own time. You could also shield your portfolio from the taxman by using various tax-wrappers such as ISAs and SIPPs.
It is therefore of crucial importance for all of us to understand how we build a suitable investment portfolio that is bespoke to our personal objectives, financial situation, concerns, interests, time horizon and risk considerations. It’s vital to understand the detail of your portfolio because the investments you own will drive the overall performance and dictate whether you’ll get to the target you’re aiming for.
Whether you’re starting your investment journey or want to discuss the impact of economic or political news on what you already hold you can find regulated investment advisers on the FCA website who can discuss a bespoke portfolio as part of your wider financial planning.
Tom is a chartered MCSI, FCA regulated investment advisor