Ten Steps to Financial Freedom
Invest! Seriously, It's Simple
What would you do if we said you were missing out on an investing strategy that, in the long run, has produced returns that far outweigh those offered by a building society? One that outperforms cash in a deposit account or bonds? Well, meet the stock market.
Internet bubble and Black days included, over the last 90 years or so, the London Stock Exchange (LSE) has returned an average annual rate of around 11%, outperforming bonds and cash in a deposit account by 6%. Over periods of five years, the returns from shares have historically beaten cash around 80% of the time. Over ten years, this rises to about 90%, and for twenty-year periods, it's 98%. With odds like that, investing for the long term anywhere else is almost certainly a losing proposition.
Investing in the stock market can be financially savvy, simple, and inexpensive.
Investing in the stock market: funds vs. shares
You can invest in the stock market by buying shares in an individual company, or by investing in a fund, which consists of a variety of shares in different companies – sort of like a basket of shares. With shares, as the value of the share itself (a publicly-traded company) goes up or down, the value of your investment does the same. With funds, the value of your investment is tied to the value of the fund, which is reflective of the value of the shares the fund is comprised of. It follows that one share's movement has a smaller impact on the fund as a whole, and thus on you, than it would if you had all your money tied up in that share alone. You do pay a price for the relative stability of funds, and that's the fund management fee – all funds have these.
Perhaps the biggest challenge with the stock market is knowing what to buy and when to buy it. Most people don't have the time to do all the market-watching and company research necessary to fill a portfolio with star shares, but we do. Champion Shares, The Fool's share-tipping newsletter, sends at least a dozen market-savvy tips straight to your inbox each year, as well as additional suggestions as and when they arise, telling you what to buy and when to buy, sell, and hold it.
Introducing the index tracker
Individual shares and funds not to your tastes? The index tracker might be your best investment option. An index tracker is a fund that copies one of the main stock market indices (like the FTSE 100, for example) so that by buying into a tracker, you can buy the overall market without having to pick individual shares. The FTSE 100 contains the hundred largest companies on the UK market, with each company weighted according to its market value. This means movements in large, usually more stable companies like BP, GlaxoSmithKline and Vodafone affect the FTSE 100 index much more than smaller companies.
Index trackers charge less than other funds. A good index tracker will cost you 0.5% a year in charges whereas a managed fund, where a fund manager chooses shares for you, will set you back around 1.5% a year, plus an initial charge of 5% for investing your money in the first place.
Index trackers vs. managed funds
Because of their higher charges, it's reckoned that in the long run, around 80% of managed funds perform worse than index trackers. You might be able to pick a fund that does better the market, but the odds are heavily stacked against you. For the majority of people, a regular investment in an index tracker is pretty much the only stock market investment they'll ever need.
A final note on investing
As a rule, the longer you invest for, the greater the chance that you'll do well. Investing for the short term, which we would describe as less than five years, is certainly risky. But when you're investing for your retirement you can afford to be a bit more patient.
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10 Steps to Financial Freedom
