What should you consider before investing?
Contributor: London Stock Exchange |
Financial markets provide a marketplace for you to buy and sell assets like shares, bonds, currencies, derivatives and even physical products like commodities. London Stock Exchange offers a marketplace for those securities.
What is your attitude to risk?
Generally speaking, investors who take greater risk achieve greater returns, but this is not always true. Taking on greater risks means you must feel comfortable with the prospects of long periods of underperformance with the aim of achieving high returns over the long term.
So, you need to understand your own attitude to risk, and that might involve asking yourself what would happen if you lost some or all of the money you have invested. If you are only prepared to accept very low levels of risk, then you are likely to achieve low returns.
If you want to take greater risk in the expectation of greater returns, then you may need to hold your investments for the longer term – perhaps five or 10 years. This will allow time for any short-term low performance to be resolved.
There are two main kinds of risk that could have an impact on your investments: unsystematic and systematic. Unsystematic risk comes from the company or industry you invest in and can be reduced by diversification. News that affects the share price of a small number of companies, such as a strike, is an unsystematic risk.
A systematic risk is inherent to an entire market or market segment, such as a poor economic performance. It is also known as volatility and involves the day-to-day fluctuations in share prices. This kind of risk cannot easily be mitigated by diversifying your portfolio.
Diversify your investment
Diversifying your portfolio by spreading the risk across different assets and asset classes is a useful way to reduce the risk to your investments.
Holding shares in just one company, or a basket of businesses within a certain sector, such as retail, can leave your investment open to additional risk.
If that single company has a bad year and its share price underperforms, or if the sector takes a sharp downturn, then you will lose money on your investments.
Diversification can mitigate this risk and although it is not a guarantee of investment success it can help to protect your portfolio. Exchange traded funds (ETFs) have become popular in part because they can be traded like shares but consist of a basket of underlying investments that offer in-built diversification.
The different asset classes in a well-diversified portfolio have different levels of risk. You might, for example, invest some of your money in shares, which tend to have the highest potential for growth and the highest risk. You could also invest in bonds that are more stable but often have more modest returns and keep some money in cash, where it is most secure but is likely to give you the lowest returns.
There are other assets to consider, such as commodities and real estate. Because diversification can be complex, you may need the help of a financial adviser or technology that can provide what is known as ‘robo-advice’. Which you choose may depend on the complexity of your strategy.
When you invest in shares you can benefit from both income and capital gains. Both of these can attract tax and you may also be charged stamp duty on your initial purchase. There are some tax-efficient products that can help you limit your tax liability. You should talk to a legal or tax adviser before deciding which may be right for you.
- ISAs: shares bought as part of an individual savings account (ISA) are exempt from capital gains and income tax. This year you are allowed to invest £20,000 into a Cash or Stocks & Shares ISA. A Cash ISA is similar to a bank account and is very secure, while a Stocks & Shares ISA invests on the markets with the aim of achieving higher growth
- Pensions: tax relief is available from the UK government when you pay into a pension, but you can’t access the money until you are 55, when you can take 25% as a tax-free lump sum. Self-invested personal pensions (SIPPs) offer the same tax advantages as other pensions but you have a greater opportunity to choose the underlying assets
- VCTs: Venture Capital Trusts (VCTs) are listed on the London Stock Exchange. They invest in a range of small, early-stage companies and are relatively high risk. The tax rules can be complicated, and you should speak to your financial adviser before investing
Tax on shares can be extremely complex and you should always seek advice from experts, such as financial advisers, accountants and HM Revenue & Customs.
How can you trade on our markets?
When you buy and sell securities on our market you have to use a broker certified by the Financial Conduct Authority. There are various types of broker offering different services and charges.
An execution-only broker will buy and sell shares on your behalf according to your exact instructions. They charge a commission on the trades you make.
An advisory broker will also buy and sell shares on your behalf and will give you advice on the decisions you are making, for which they will charge a fee.
A discretionary broker can buy and sell securities that you want but will also have the authority to make investments without your prior approval. This has the benefit of making trades faster and grabbing valuable opportunities when they arise. Many of these firms now include financial planning as part of their services. Again, they charge a fee for this service.
Contact a broker
If you want to invest in London Stock Exchange listed securities, you must first contact a broker and instruct them to invest on your behalf. Decide if you want them to provide an execution only, advisory or discretionary service. You can either ask them to buy a specific number of shares or other securities or give them a specific amount to invest.
You can search our Broker Directory to find a UK retail broker suited to your needs.