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Five rules for smart investing

There are two common misconceptions when it comes to investing. The first is that investing is only for the already wealthy. The second is that investing can, or should, be a way to make money quickly by taking advantage of the more extreme market movements. 

Neither is true. You can absolutely invest on a budget with some smart planning and, when it comes to investing, it’s often ‘slow and steady’ that wins the race. 

So, this is not a get rich quick guide to investing, nor is it a rundown of exactly where to put your capital. Instead, these are five key rules to live by when setting out on your investment journey. 

Take a long term approach

When a lot of people think about investing they think of trading. The idea that, by making the right investment moves, you can get rich quick is a pervasive and persuasive one. It’s also largely a fallacy. 

Of course, back the right stock at the right time and you can see quick returns, but the reality is that very few people can do this. For those without forensic knowledge of market movements and, let’s face it, incredibly good luck, the best way to make money on the markets is ‘slow and steady’. 

The longer you have to invest, the more risk you can absorb along the way. The more risk you can absorb along the way, the greater the eventual returns you could see on your portfolio. The ability to ride out any falls and wait for the eventual recovery is a luxury long term investors can take full use of. 

Jumping in and out of the market based on emotion or instinct can be a surefire way to cement losses. We’ve written extensively about the pitfalls of disinvesting during uncertainty or taking a short term approach to investments and the conclusion is always the same: a long term investor is a smart investor.

Diversification is key

This is a guide for sensible investing – how to make your money work for you without exposing yourself to unnecessary financial risk. It is, then, impossible to leave effective diversification off of this list. 

Existing for decades but made easier by global digitalisation, diversification allows investors to reduce correlation and spread their risk across a number of industries, geographies, currencies and asset types. These can be time-consuming and expensive to pull together, though, so collective investments have become a popular option for those who want a slice of the diversification pie. 

For example, at Moneyfarm we favour the use of exchange-traded funds (ETFs). They’re an effective diversification tool and they’re low-cost, making them an ideal way to reduce risk across a portfolio without costing an arm and a leg. 

Diversification goes hand in hand with a long term approach. Spreading your investments over a variety of geographies and currencies means that you can offset losses in one area with gains elsewhere. Putting all your eggs in one basket is rarely a good idea – why would it be any different when investing? 

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Define your goals clearly

Just as with anything in life, sound planning can make a big difference to your investment journey. To know whether your investments are on track, you have to have a solid idea of what the destination looks like. Once this has been established, the details of those investments can be figured out. 

There are a number of factors you need to consider before you get started and regularly assessing your progress is key. These factors are: 

  1. What am I saving for?
  2. When do I expect to access my money?
  3. How much can I afford to invest each month?
  4. What is my risk profile?

Knowing your goals allows you to balance how much you put away each month with your proposed retirement date, for example, or the date you want to buy a new home. This also allows you to choose a risk/return balance that’s right for you, specifically. 

Use your allowances

Every year, investors are given an ISA and pension contribution allowance that allows them to enjoy generous tax breaks. To make sure you’re getting the most out of your investment portfolio, it pays to be aware of these limits and to factor them into your planning. 

For ISAs, the tax-free wrapper is limited to £20,000 per year. This means that any income you make from investing this amount will be shielded from the taxman. For pensions, the annual cap is your annual salary or £40,000, whichever is lower. 

If you are fortunate enough to be in a position to max out your ISA contribution year on year, you absolutely should. Equally, if you were to inherit a lump sum and wanted to invest it over time into a tax-efficient ISA, it pays to be aware of the limits. 

Trust people as well as technology

Over the last decade or so, the notion of a ‘robo-advisor’ has become mainstream. Younger generations are getting more and more comfortable handing over financial information and control to machines with the promise of efficient wealth management. 

There is a lot to be said for technology’s ability to analyse performance, highlight areas of weakness in an investment portfolio and seek out potential areas of opportunity, but there is no algorithmic magic wand to investing. 

A piece of technology is only as good as the people underpinning it. This is why, at Moneyfarm, we firmly believe that the expertise of our team is our core strength.

There is merit in using technology to inform decision-making. Our asset allocation team uses technology to monitor the health of our investment decisions, for example, while our investors can track their performance, initiate transactions, get support and more just by using our app or web service. No investment service should be fully automated, however. In times of turbulence, it’s more important than ever to trust expert decision-making and qualified advice.

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