An Investment Starting Point
Written by David Rosbotham DipPFS | Financial Planner | Jan 25
Introduction to Investing
Brief overview: What is investing?
Purpose: Growing wealth, building financial security, and outpacing inflation.
Target audience: For those starting their investment journey or wanting to understand the basics.
Key Investment Terms to Know
Stocks: Shares of ownership in a company. Stocks typically yield higher returns than traditional savings.
Bonds: Loans given to a company or government that pay back over time with interest.
ETF (Exchange-Traded Fund): A diversified collection of securities that trades on an exchange, good for beginners.
Portfolio: Your entire investment collection, which should be diversified for balance and stability.
Risk Tolerance: Your comfort level with possible fluctuations in investment value.
Compound Interest: Earnings that accumulate on both your original investment and on any previous returns.
If you invested £10,000 which compounded annually at 5%, it would be worth over £40,000 after 30 years, even without making any additional contributions to the investment.
If you invested the same £10,000 but it compounded annually at 8%, it would be worth over £100,000 after 30 years. Accruing over £90,000 in compounded interest.
The Benefits of Long-Term Investing
Stock Market Growth Rates: Historically, the stock market has averaged around 8-10% annual returns. This makes it a powerful tool for building wealth, especially when compared to low-interest bank savings.
Compound Interest Effect: Compound interest makes your money work harder as returns grow on returns over time. The longer the time horizon, the greater the compounding effect.
Risk Reduction Over Time: Market fluctuations tend to smooth out in the long run, and a diversified portfolio can help reduce risk.
The chart below illustrates two hypothetical investment strategies in the S&P 500 over a 20-year period ending on December 31, 2023. Both investors contributed $10,000 annually. One investor managed to invest on the lowest day of each year, achieving an average annual return of 12.64%. The other investor, investing on the highest day each year, saw an average annual return of 10.78%.
After 20 years, despite investing at the worst times, the cumulative $200,000 investment still grew to $640,469. This demonstrates that, even with poor timing, staying invested in the market over the long term can yield significant growth. While regular investing doesn’t guarantee profits or protect against losses, the examples below highlight its potential advantages over time.
Source: S&P 500 Index
The Dangers of Sitting in Cash
Inflation Risk: Inflation erodes the value of money over time. Even with moderate inflation rates (e.g., 2-3%), cash left idle loses purchasing power each year.
Missed Growth Potential: Money not invested loses the opportunity to grow through compound interest and market returns, making it difficult to reach long-term financial goals.
Investment Strategies: Passive or Active?
Passive Investing: A more hands-off approach, often via index funds or ETFs, that aims to replicate the market’s performance. Typically lower-cost, ideal for those with a longer time horizon who seek steady growth.
Active Investing: Involves researching and choosing individual investments, possibly guided by professional managers, with the aim of outperforming the market.
Case Study: David, Paul, and Roy
Here’s an example to illustrate the difference between three approaches:
David: Keeps his money in cash, thinking the stock market is too risky. With inflation, his money decreases in value over 25 years.
Paul: Starts investing $1,000 per month immediately. Over 25 years, he benefits fully from compound interest.
Roy: “Too busy” with work to take action. Delays his investment for 8 years and then starts putting in $1,000 per month. Although he benefits from investing, he misses out on 8 years of growth, resulting in a lower end balance than Paul’s.
Projected Investment Outcomes for David, Paul, and Roy
Let's illustrate this scenario, assuming an annual 8% growth rate:
David (No Investment, Cash Only):
Amount after 25 years: Remains constant in cash, but its real value declines due to inflation.
Paul (Invests £1,000 Monthly Right Away):
Invested amount over 25 years: £300,000
Future Value after 25 years at 8% growth: £950,000+
Roy (Starts 8 Years Late with $1,000 Monthly):
Invested amount over 17 years: $204,000
Future Value after 25 years: $540,000+
Paul ends up with a significantly larger sum than Roy, showing the benefits of starting early. David, meanwhile, sees his purchasing power decrease.
Conclusion and Takeaways
Start Investing Early: Even small amounts benefit from compounding.
Understand the Effects of Inflation: Cash isn’t risk-free when inflation is factored in.
Avoid Inaction: by delaying or being inactive you are missing out on potential growth.
Consider Professional Help for Active Management: For beginners, with busy lifestyles due to career and family - passive strategies may be the most suitable option.
Partnering for Financial Success
Are you curious about how financial planning can add value to your financial journey? Take the first step towards securing your financial well-being by reaching out to us today.
We invite you to schedule a free, 30-minute introductory meeting with our experienced planner, David Rosbotham. Or find out more about our approach to financial planning.