It’s a frustrating time for savers. Rates on bank accounts are in the doldrums yet many are finding they are putting away more because their outgoings have dropped amid the pandemic. So is the stock market a good next step?
It may be tempting to dive in, especially after headlines last week proclaiming huge gains for investors in US video games retailer GameStop. But the flurry prompted concern that the inexperienced would make risky mistakes with their money.
“UK investors should approach these share price moves with extreme caution,” says Richard Hunter of Interactive Investor.
Rather than buying into individual companies, for those who do want to enter the markets, funds are a good starting point.
They give investors the comfort of not going it alone, as your money is pooled with that of others in a selection of stocks. For beginners, the first choice is usually between two types: index trackers and managed funds.
Index tracker funds follow the movement of an index, such as the FTSE 100. When the index goes up, so does the value of the fund: when it goes down, so does your investment . These “passive” funds may hold all of the shares in proportion to what size they are in the index, or a selection of shares which broadly reflect the overall performance. Because following the index means managers do not have to research and decide what to buy, tracker funds are generally the cheapest.
“They are designed to closely mimic the overall returns on a particular market, for a small fee. This will be a fraction of the cost of an actively managed fund, as there is no well-paid team to clothe and feed,” says Jason Hollands of financial advisers Bestinvest.
“When you invest via trackers you are swapping the potential to get market-beating returns that you might get with a really strong actively managed fund, but you are also removing the risk of a manager making a mess, while saving costs, too. Trackers, therefore, offer a low-cost, low-maintenance approach.”
Problems can arise with trackers if the index they are following is weighted in favour of one type of company. If this sector falters, then the fund suffers – such as when the dotcom bubble burst, or during the banking crisis.
The way investments are weighted can also mean that the fund does not hold many shares in smaller companies, which may rise. “Many UK tracker funds follow the FTSE All Share Index. On the surface, this gives you exposure to 609 companies, of which 258 are smaller companies. However, in practice, your exposure to the 258 will get zapped down to a meagre 3.4% of the fund, fewer than you’ll have in HSBC, a single bank,” says Hollands.
Damien Fahy of personal finance site Moneytothemasses.com says the typical cost of an index tracker is between 0.1% and 0.5% per annum. So, if you invest £1,000, you could pay between £1 and £5 a year. They are good for “buy and forget” investments, but can’t beat the market as they are mirroring its success. Overall, they are the best option for most investors, especially those with long-term investment plans, he says.
More expensive and more involved are managed funds – where a manager or team picks out investments. Fahy says that these are a good choice for people who are more actively engaged in their investment and willing to regularly research and review where their money is going. Charges tend to be between 1% to 1.5% a year, he says.
Hollands says the best managers can justify their fees but many disappoint. “Once you have chosen an actively managed fund, it is important to keep an eye on it, because managers can go off the boil and, of course, they can change jobs or retire, which might mean they are replaced by someone with a less impressive track record,” he says.
“A particular approach can work very well for a period, but then fall from grace for a period. In recent years, managers who focus on high-growth companies have done a lot better than those who seek to pick up undervalued shares, but it hasn’t always been that way and may change at some point.”
An abiding rule is that you should invest for a minimum of five years to ride out any bumps in the market. Martin Lewis’s Moneysavingexpert recommends that the first port of call should be an Isa, where all adults have a £20,000 tax-free allowance.
A stocks and shares Isa allows you to invest in stocks but also in funds. Firstly, you choose which provider to go with – such as Hargreaves Lansdown, Interactive Investor or Halifax, among many others – and then decide on the funds you would like to invest in.
Consumer group Which? warns investors to watch out for fees – even though the percentages may appear small, they can run into hundreds of pounds a year no matter whether the fund has performed well, or not. “Savers with less to invest are likely to be better off selecting an investment platform provider with a percentage-based fee, rather than a fixed fee,” says Gareth Shaw, Which? head of money.
Investing is not an either/or choice, however. Having a mix of different funds can spread risk. “Building a portfolio of funds, whether active or passive, can be daunting and does require plenty of research. But on the plus side, you can build one that gives you exposure to themes or companies you are interested in,” says Fahy.
Hollands suggests a consistent monthly investment, rather than a one-off lump-sum payment. “Many people are put off because they worry about timing, and it is easy to get anxious when the headlines are either gloomy, or commentators are trying to second-guess whether the market is too expensive, or cheap.
“Investing often, in bite-size chunks, removes the need to deliberate about timing and is a great discipline to keep you going through the downs, as well as the ups. In doing so, it helps to smooth out the prices you pay for your shares across the year,” he says.
Find out which funds to avoid
Investing in a fund can be done via a “platform” where you can buy and sell investments and which is the cheapest way to invest. The one to choose depends on how often you want to trade, and the fees that are charged.
Moneysavingexpert picks iWeb as a cheap, no-frills option while AJ Bell is good for those who are going to make more than 10 trades a month. In between, the site recommends Interactive Investor as a good choice for someone who makes a few trades a month.
Find out which funds to buy with Bestinvest’s regular “Spot the Dog” report which shows up the worst performers.
This article was amended on 1 February 2021. An earlier version said the the typical cost of an index tracker is between 0.1% and 0.5% per annum so that “if you invest £1,000, you could pay between £10 and £50”. That should have said between £1 and £5 a year.