Investing 101

If you’re new to investing, this article is to outline if you should look at ‘active investing’ your money or if ‘passive investing’ is favourable in your circumstance.

This article aims to be unbiased towards either type and will weigh up the pros/cons of each.

Before we start…

Have you gone through the flowchart? – Make sure you’re at the stage where you’re ready to invest.

What is investing?

Investing is the process of buying an asset like shares in a company with the expectation of profiting over time. Almost everybody holds investments, even if they don’t realise it. If you have a workplace pension, you are an investor!

Investing is necessary because the spending power of money reduces over time, thanks to inflation. In general, savings accounts pay interest at a lower rate than inflation, and so even if the cash balance itself doesn’t reduce, the spending power of that money does.

What assets?

We mentioned buying an asset above, but what does that actually mean? The best understood option by most is the buying of shares, or “equities”. When you buy shares, you are actually buying ownership of a very small slice of the company in question. You will participate in any distributions of profit (dividends) and you may expect the value of those shares to increase over time.

Other investment assets include fixed-interest securities (also known as bonds), where you lend money to a company or government, usually with the promise of regular income payments (coupons) and the return of your originally invested capital at a predetermined date.

With both of these investments, there is some risk that the attempt to generate profit goes wrong, and the money is partially or completely lost. This risk is exactly why we expect to get a profit from investing. If there was no risk when lending money then borrowers would not have to offer to pay back extra or give part of their profits.

It is crucial to keep the concept of “risk” in mind when thinking about investing. On the surface, making 50% returns on an investment sounds much better than a 5% return, but if the chance of losing all the money in the first example is 50% and the chance in the second example is only 1% then the risk-adjusted return is actually far worse.

What are “passive” and “active” investing?

A passive investment strategy involves depositing money into a fund. This fund will have your money automatically invested and diversified across many companies with no effort from you.

Active investing is a strategy where you make the decisions on what stocks to buy.

Both types require a little bit of research to start, however “active” investing will require constant research into the stocks you are buying to make the right decisions.

You can combine both passive and active investing. Utilizing a S&S ISA (Stocks & Shares ISA, a tax-free wrapper for earnings) for one and having a GIA (General Investment Account) for the other.

So, what should I chose?

If you’ve read to this point and still uncertain, here are a few last points.

Are you prepared to spend a lot of time researching – trading during market open hours every weekday, for a lengthy amount of time, with the slight possibility you might outperform global benchmarks?
For the majority of investors (both professional and individual), their time is worth more than they will beat in global benchmarks.

Your time is valuable. Spend that time doing something you enjoy, whether it be reading, cooking or learning.
This article about the value of time by James Clear is a very good read.