Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
We all invest for different reasons. Some of us may be looking to build up an income for retirement, others to buy their first house. Perhaps you’re hoping to ride the latest stock wave to generate returns over the short term, or instead gradually accrue savings for the future.
As young people, we’re likely to share similar objectives, but nobody’s will ever be exactly the same. Here are some key questions to consider as you look to save toward your personal goals.
ISA vs pension
Considering whether to invest in a pension or Stocks and Shares ISA essentially comes down to whether you’re saving for retirement or everything else. As it happens, you should really be thinking about both.
Retirement probably feels miles off but the sooner you can start saving for it, the better. By way of a process known as ‘compound interest’, any return you make on your investments builds your capital and gives you an even bigger base to grow in the future. This can have a dramatic effect on your savings over the long term. If you delay your pension, you may have to make up ground later.
There are also certain tax advantages to saving through a pension, such as ‘tax relief’. You can find out more about these here.
But investing in a pension can be limiting. A key difference between a pension and an ISA is that you won’t be able to access any money you put into your pension until you turn 55, under the current pension rules.
An ISA is a far more flexible way to save for all eventualities. You can invest up to £20,000 each year into an ISA and enjoy tax benefits which also make it an efficient place to hold your investments. You don’t get the same tax relief on your ISA savings as you do in a pension, but all the gains you make within an ISA are tax-free.
Whatever your priorities, the same golden rule applies to both ISAs and pensions - the sooner you start, the better.
Active vs passive
Once you’ve decided what you’re saving for, you’ll want to think about how best to achieve those goals and which funds best suit your objectives.
At the highest level, there are two styles of fund - active or passive. Each has its own advantages which may chime more with your personal approach (or you may prefer a combination of both).
Passive funds look to limit the amount of stock selection and trading they engage in and, by extension, the fees investors have to pay. As such, these funds are likely to invest in an a major stock index - for example, the FTSE 100, which is a composite of the 100 largest companies listed on the London Stock Exchange - to ensure they perform directly in line with the market as a whole, minus fees.
Fundamentally, passive investors think there’s little worth in trying to outthink the market and are happy for their funds to track the performance of the index. Active managers, on the other hand, reckon they can outperform it through some savvy stock selection. That means they will invest only in companies which they feel are likely to perform better than the index as a whole.
Say an active manager invests in 20 stocks from the FTSE 100 - if those 20 stocks do particularly well, and the remaining 80 do poorly, then the active fund will outperform the passive. Because of the additional work involved and the higher levels of stock trading, active funds are likely to charge more than passive - but the idea is that all that added cost will help deliver higher returns.
Our Select 50 choice of favourite investments primarily consists of active funds, but if passive sounds more up your street, you can check out list of Select ETFs. ETFs are a popular and accessible form of passive fund. You can find out more about them here.
Growth vs value
Once you’ve thought about which kind of fund suits you, you’ll want to get to grips with the various styles and processes that different managers adopt to achieve their investment objectives.
There’s not the space here to go through every consideration that factors into a successful fund. Each manager will have their own unique philosophy. So, let’s think about one question that most will at least consider - whether they prefer growth or value investing.
Growth and value refer to two different investing styles. Growth stocks are those which look set to deliver rising earnings, regardless of what’s going on with the wider market. They’re considered to have good potential for growth over a number of years, often because of some unique attribute which gives them an edge over competitors. Because returns from these companies appear reliable, growth funds tend to attract a high cost.
Value investors, on the other hand, look for stocks they believe are trading below their true value - ‘true’ here often refers to the price that analysts think the company is worth. The idea here is that value investors buy stocks cheap before they eventually return to their true value and thus deliver meaningful capital growth.
There are several reasons why a company may trade below its true value. Stock prices are determined by market perception - if most investors feel the stock isn’t worth much (maybe the company has been embroiled in a scandal, or is restructuring), its share price is likely to tumble. Think about when you go to buy a sandwich, and every so often the supermarket is selling one at a discount because its packaging has been damaged. The true value of the sandwich itself hasn’t necessarily been eroded - it will still taste the same - but because it appears to have been damaged, you bag it on the cheap. The value investor will be licking their lips.
Value vs growth is a pretty divisive subject in the investing world. Growth supporters have had plenty to boast about over the past decade, during which time those stocks have massively outperformed their value counterparts. But there are diehard value loyalists who continue to back the style, and they may have a point. History suggests that the tides will eventually turn back in favour of value.
It’s important to note as well that you don’t have to be one or the other - many fund managers are pretty agnostic over which works best. And even then, there’s nothing stopping you from holding a blend of both.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. Select ETF is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
A secret tax grab - and how to beat it with your pension
Will you be caught by the income tax band freeze?
What’s wobbling stock markets - and what to do about it?
This week, we’re digesting the market’s volatile movements in response to a h…