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What should you consider before investing in the stock market?

How have stock markets performed ten years on from the collapse of Lehman Brothers and one of the largest stock market crashes in history?

Topic: Investing

If you're new to investing, you may be scared that it is dangerous and unsafe.
But here are a few reasons why you shouldn’t be.

Why do investors choose shares over cash?

The MSCI World is a stock market index that is often used to benchmark the performance of global stock markets.

The graph below illustrates that the MSCI has delivered better performance
than that of a savings account.

  • MSCI World Index

  • Value of cash

A cash savings account that followed the Bank of England
base interest rate would have returned £1,037.

An investment in the MSCI World Index at the same
time would have returned £7,441.

Source: Factset 2018 with data supplied by Click & Invest

  • A history of low interest rates
    over the last ten years means
    that cash savings are struggling
    to keep up with inflation

  • When investing, there is always a
    risk that your investments could
    go down as well as up. However,
    there is also the potential for your
    returns to outperform inflation

So, how can you guard against risk?

The importance of diversification

Investors use diversification to minimise the risk associated with investing.
At Click & Invest, we always invest in a number of asset classes and
not just Stocks and Shares.

As the graph below shows, when Facebook’s share value dipped in 2012,
Biotech stock was on the rise, helping to mitigate the risk of loss across
an entire portfolio.

  • Facebook IPO

  • Biotech ETF

  • Gold

Since 2011, a £10,000 investment in Facebook took
a very different journey to Biotech or that of Gold.

As we can see, investments can go down as well as up. At Click & Invest,
depending on your appetite for risk, our Investment Managers will place
you in one of five different investment portfolios in order to give you
the exposure to risk that best suits you.

Source: Factset 2018 with data supplied by Click & Invest

  • To guard against exposure
    to risk, it’s important to build
    your portfolio with different
    asset classes, such as Stocks
    and Shares, Gold, Bonds and Cash.

  • While a diversified portfolio is key
    to guarding against risk, investing
    is only appropriate for those with
    long-term financial goals. The longer
    you invest for, the greater the
    chance you have of being able
    to ride out any fluctuations in
    the markets

The final graph shows the beneficial power of compounding
interest to grow your investment.

The power of compounding returns

Compounding describes how the value of your investment can
snowball, as your earnings are continually reinvested. The graph
below demonstrates the exponential growth that your investments
could make over time.

  • Facebook IPO

  • Biotech ETF

The graph shows the impressive effect of compounding on two very different
stocks – Facebook and Biotech. Both achieved growth in excess of four times
the original investment.

Source: Factset 2018 with data supplied by Click & Invest

  • Reinvesting your earnings
    can help you achieve
    exponential growth on
    your original investments

  • The longer you leave your
    investments, the greater
    the opportunity there
    is for them to grow

Continue scrolling to discover how you could harness the power of
compounding interest.

Key takeouts when investing

Below we’ve listed five top tips to consider before you decide whether to invest.

  • Timing

    While the old adage of ‘time in the market, not timing the market’ is a useful tool for financial success, it also pays to be responsive and to keep an eye on current affairs.

  • Healthcare

    With an increasing and longer-living population, the healthcare industry is growing fast. Biotech stocks are certainly worth keeping an eye on.

  • Technology

    Tech disruptors offer a good opportunity for investment but keep an eye out for companies that are not innovating – they’re likely to get left behind.

  • Property

    Maxed-out markets and rising buy-to-let costs are reducing the efficiency of property investments. A well-managed portfolio of stocks and bonds is more liquid than property and could offer some downside protection.

  • Gold

    Investing in the shiny yellow stuff may have a reputation as a ‘safe haven’, but it’s good for diversifying your portfolio because it typically retains its value, even if stocks and/or bonds go down.

Continue reading to learn more about investing and how you could benefit from a diversified portfolio and the power of compounding interest below.

All investment carries risk and it is important you fully understand these risks and are willing to accept them. You may get back less than you invested.

The ups and downs of investing

September 2018 marks the 10-year anniversary of Lehman Brothers’ bankruptcy, and one of the largest stock market crashes in history. The impact was felt by everyone, from financial institutions to the consumer on the street.

Inevitably, investor confidence took a knock but markets have recovered, despite some fluctuations. As with a decade ago, the investment strategies for long-term gain are as important as ever.

Here, we look back at the performance of stock markets since 2007 and explore how those strategies have played out.

From the graphs in the infographic above, one can clearly see how stocks have recovered since the crash in 2008. What’s also very clear is the importance of holding a diversified portfolio and how compounding can have an exponential impact on your original investment.

Saving v Investing

It’s events like the 2008 credit crunch and the tech bubble burst in 2000 that can make many people wary of investing in the stock market. However, to focus purely on the immediate impact of those events is to ignore the long-term gain that it is possible to achieve through investing.

Even if you had invested £10,000 in the MSCI World Index at the start of 2007, before the 2008 crash, your investment would be worth over £20,000 by the end of August this year. If you’d put the same amount in a cash bank account, paying interest at the Bank of England base rate, that cash would only be worth just under £11,700. ¹.

Over those 10 years, the MSCI World Index certainly suffered some ups and downs, serving to highlight how investing is more suited to long-term goals. If you’re saving for that dream holiday or a new car, then investing may not be the best option for you.

However, investing may be more suitable if you’re focused on a long-term goal, such as buying a property or seeing your children through university. Whatever your goals, though, it’s important to be aware of the risks associated with investing.

The importance of diversification

One of the ways that you can protect your investments is by building a diversified portfolio across a range of asset classes, sectors and geographies.

In an ideal world, every asset in your portfolio would perform well all the time. But history shows that no single investment will be a constant top performer. For example, while Facebook was enjoying an excellent year in 2013, gold bullion was doing quite the opposite.

Diversification may not necessarily improve the overall performance of your portfolio but it can offer greater protection against poor performance than if you had all your money invested in one asset or asset type.

The make-up of a diversified portfolio will take into account your goals and time horizons, as well as the level of risk and volatility that you’re comfortable with.

The power of compounding returns

Whatever the contents of your portfolio, one key factor to bear in mind is that the longer you’re invested the more gains you could stand to make.

This is not only down to your ability to ride out fluctuations in the market but also to the exponential impact of compounding. Described by none other than Einstein as the eighth wonder of the world, compounding refers to the effect of reinvesting the interest earned on your initial investment.

Our graph above shows the impressive growth achieved by both Biotech and Facebook stocks when the returns were consistently re-invested over time. Or to use another example, if you’d made a one-off £5,000 investment in the FTSE All Share in 1986, it would have grown to £28,357 by the end of 2016. However, if you’d reinvested all the returns over that same period, then your original investment would have grown to £88,396. 2

To benefit from the effects of compounding, you need to reinvest any dividends earned from your original investment instead of taking them out as cash payments. The longer you’re invested for, the greater the impact of compounding.

A long-term view

To coin a phrase, you do need to be prepared to take the rough with the smooth when you’re investing. The crashes of 2000 and 2008 are evidence of that. But with the right strategies and a long-term outlook, investing could be perfect for helping you achieve your financial goals.

¹ Source: Factset 2018 with data supplied by Click & Invest

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