Looking back

27 Sep 2019

Ian Cowie

Financial Columnist

Things this 60-year-old investor wishes he had known when he was 16.

It is not the sort of thing they tell you at school, but when you leave and make your way in the world as an adult, money will be part of the core curriculum. Unlike, say, art or physics, it is not a subject from which you can opt out, unless you are willing to live in a cave on a diet of roots and berries.
“Money is like a sixth sense without which you cannot make a complete use of the other five.”
- Somerset Maugham
 
The great English playwright, Somerset Maugham, put it more positively: “Money is like a sixth sense without which you cannot make a complete use of the other five.” Passing life’s practical pecuniary tests will determine where you live, what choices you can afford to make (including what you do for a living) and even how long you live, because there is a wealth of statistical evidence to show that wealthy people tend to survive several years longer than those who are poor.
 
Sad to say, money remains the last taboo and is rarely mentioned in school, unlike some subjects which may be of little use to most people in adult life. So here are a few of the things this 60-year-old wishes he had been told when he was 16.
 

Make money work for you

 
Most people spend their lives working for money, but saving and investing makes money work for you. Better still, money never sleeps. That means savers can earn interest and investors can generate capital gains and income from funds and shares, even while we are in bed. This should leave you more time to do what you like, whether that is sailing, skiing or anything else, and of course the ability to afford it.
 

Identify your objectives

 
Short-term objectives, such as expenditure expected within the next year or so, are most safely met with bank or building society deposits because you can be sure the cash will be there when you need it. This includes holidays or tax bills, for example. However, low risk bank or building society deposits are likely to deliver low returns. Many deposits do not even match the rate at which inflation is eroding the real value or purchasing power of money.
 
More than a century of evidence analysed and updated each year in the Barclays Equity Gilt Study shows that shares tended to deliver greater returns than cash over the medium to long term. Where shares were held for five consecutive years or more, they did better than cash 75% of the time. If the holding period was extended to 10 years, the probability of shares beating cash increased to nearer 90%.

 

Understand the difference between risk and volatility

 
Share prices can fall without warning and you may get back less than you invest in the stock market. The tendency for prices to unpredictably fall or to fluctuate in either direction is known as volatility. However a loss on paper, or alternatively, a paper gain, is not the same as a real one unless you sell.  
 
So, shares’ well-known price volatility need not be a real problem unless your personal circumstances force you to sell. You can reduce the risk of being forced to sell when prices are temporarily depressed by only investing money in the stock market that you can afford to commit for five years or more.
 

Diminish risk by diversification

 
The first rule of investment is sometimes said to be ‘spread risk’. The principle is the same as the adage not to have too many eggs in one basket. By spreading your money over a variety of different companies, commercial sectors, countries and currencies you can reduce the risk that they all go up or down at the same time. Pooled funds, such as unit and investment trusts, automatically diminish risk by diversification. This is achieved by allocating assets over dozens of different companies or businesses (and in the case of international funds, different countries) to reduce individual investors’ exposure to setbacks or failure at any one of them.
 

Buy on the dips

 
The best time to invest is often when you least feel like doing so; when investor confidence is depressed, asset prices are also likely to be depressed and the first step to making a profit is often to buy low. You can build wealth over time if you ‘buy on the dips’ or pick up bargains when prices are temporarily depressed.
 
Investing a lump sum just before prices fall, as well as regular saving schemes and monthly investment programmes will reduce the risk of bad timing, as you are making many smaller investments spread over months and years. This can make price volatility your friend. If you invest a fixed sum at fixed intervals, you will buy fewer shares or units when prices are high and more shares or units when prices are low. This is sometimes known as ‘pound cost averaging’.
 

Consider investing internationally

 
Professional financial advice and professional fund management have brought overseas opportunities within reach of individual investors, big and small. Pooled funds, such as unit and investment trusts, as well as online platforms have made it cost-effective and convenient for British investors to build a global portfolio of assets.
 
Political uncertainty close to home makes international diversification well worth considering as a way to minimise risk and maximise returns. For example, capital gains and dividends from funds or shares denominated in foreign currencies can rise in value for British or sterling-denominated investors, even when there is no change in the base currency, if the pound’s exchange rate against the selected foreign currency falls.
 

Let time do the hard work

 
The sooner you start saving and investing the better, because the earliest pounds you set aside from immediate consumption will have the longest to roll up or grow for your benefit. Gains can grow on gains and income can be generated by income in a mathematical phenomenon known as compounding.
 
Compound interest has been called the ‘eighth wonder of the world’ because he or she who understands it earns it, while those who do not understand compound interest end up paying it. That is why savers and investors are often happier, healthier and wealthier than borrowers.
 
Savers and investors aim to build a better tomorrow, rather than one encumbered by debt. Or, as the adage puts it, those who will not work and set aside something in the summer may starve in the winter. Let time do the hard work for you by starting to save and invest as soon as possible. That way, you should pass the pecuniary or financial tests of life with flying colours.

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