personal finance

Investing without losing sleep


Question

The rate on my savings account has been cut three times in the past 12 months. I know I could get a better return by investing on the stock market, but I’m worried about losing money?

Answer 

In January, the Bank of England reported that the average rate on a standard savings account had fallen to just 0.85% per year – that’s 85p interest for every £100 you save. 

Things aren’t much better in the cash ISA market either: Moneyfacts comparison site says that the average no-notice cash ISA now pays a paltry 1.05% per annum. You may wonder if there’s any point in putting money in a savings account at all.

I can understand apprehension about making the transition from cash to stocks and shares, but cuts to savings rates have had a damaging impact on the income you can generate from your nest-egg. So you’re taking a sensible step by considering a different way to get your money working harder.

Guide to investing for beginners.

Understanding investment risk

People often see cash as a ‘riskless’ investment, in that you can’t lose the sum you’ve invested in a cash deposit account. 

But if you steadfastly stick to cash, you expose yourself to inflation if your savings don’t keep up with the rising price of goods. And with savings rates in such a dire state, you could also end up facing ‘shortfall risk’ – meaning your investments haven’t grown enough to meet your financial goals.

Shortfall risk could, of course, occur when you invest your money on the stock markets, but let’s focus on what you’re worried about: the risk that you could lose the capital you’ve invested, often called ‘capital risk’. 

This is indeed a possibility when you invest your money in company shares, bonds or other types of ‘asset’. Share and bond prices can rise and fall in value, meaning that they may sometimes be worth less than the price you paid for them. But there is a way potentially to mitigate this…

What is investment risk?

The power of diversification

This is the process of not putting all your eggs in one basket – investing in different types of asset that react in opposite ways in the same economic situation, or in sectors that move independently. By diversifying your investments, it means you are spreading the risk.

For example, say you put all your money into shares in one company. If that company’s share price slides, your entire investment is at risk. But spread your investment to include shares of another company in a different business area and it may well be unaffected by the issues facing the first firm – meaning your losses are cushioned.

You can further spread risk by buying different types of asset. 

Bonds – loans to a government or company in exchange for an interest payment – often move in the opposite direction to shares. So, when one part of your investment portfolio is falling, another may rise to offset any losses you make. 

Assets, such as property, tend to move independently of shares and bonds, which can help to spread risk and potentially boost returns.

Diversification should be the best friend of every investor. 



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