Investing in financial markets offers the potential to grow the real value of your money over the long term, which means you generate a return that exceeds the rate of inflation over a period of at least five to 10 years.
Achieving a return superior to cash will usually involve taking on a certain degree of risk, however. Learn more about understanding your risk profile here.
Share prices will ebb and flow so you should not expect investments to pay off overnight. Furthermore, trying to time the market – finding the optimum point at which to invest – is very difficult. Moving in and out of markets requires constant monitoring of news flow and events and even the best fund managers in the world find this hard to achieve successfully on a consistent basis.
This leaves you with a quandary: you want to put your money to work in the markets but what if you invest at exactly the wrong time, just before a major fall for example? To counter this, most investment funds offer a regular investment facility, allowing you to drip feed money in and reduce the chance of investing all your money just before a drop in the value of markets.
This has two major benefits: first, it helps to instil a sense of discipline to investing and, second, it allows you to benefit from what is known as pound-cost averaging. The easiest way to understand this is to consider how much a £100 monthly investment will “buy” you. When stock markets are doing well and share prices are higher, £100 will buy fewer shares. When markets are lower, however, the same £100 will buy a higher number of shares. Over the long term, these should even each other out and give investors a much smoother experience than with a lump-sum investment.
Your investment objectives, risk profile and timeframe for investing will determine the degree to which you will invest for growth and income. The former is designed to provide a larger gain at the end of your period of investment while the latter will pay a regular income and, as a result, probably a lower capital growth.
One measure of the income you can receive from your investments is a yield. Both shares and bonds can pay a yield. With a share, a company may pay a dividend to investors. The dividend yield is the yearly total of these dividend payments expressed as a percentage of the company’s share price. Bonds often pay a “coupon” that is similar to an interest payment on cash and this interest yield represents a return proportional to your holding.
By reinvesting income, you can tap the full potential of your investments and boost your wealth. If you put £1,000 into an account that pays interest of 3%, you will have £1,030 after one year. Next year, you will earn 3% on the £1,030 rather than just the original £1,000. This might not seem particularly significant but the effects can really add up over time. The Barclays Equity Gilt Study, for example, shows that the vast majority of the real return from shares (in excess of inflation) comes from compounded dividend reinvestment.