Video Transcript – The Basics of Investments
Contrary to saving accounts, where you lend money to a bank in exchange for interest, investing means that you buy something with the hope that this something will go up in value. A typical investment fund allocates money to shares issued by companies, bonds issued by companies and governments and some other types of assets such as real estate. You can buy “units” in a fund via your bank or via another intermediary (an investment firm). You are charged fees both by the fund managing company and by the bank or other intermediary. Fees are usually calculated as a percentage of the money invested e.g. 0.50% per year.
The performance of your investments will depend on the performance of the underlying assets (shares and bonds). For shares this depends on the profits made by large companies that are traded on stock markets (e.g., NYSE, LSE etc.). Investment makes sense if you are able to leave your money aside for a really long period of time. Do not think of investment as a quick way to make money or fund a holiday. If you can put some money aside each month above a safety amount of assets in bank accounts for a time of need and you know you will not be using it for many years, then it makes sense to invest. By the time you retire your money is extremely likely to have increased in value considerably. So, in short, investment is a good idea provided that:
(1) you invest in a highly diversified fund; and
(2) you are sure you will not need to sell your investment for many years, ideally more than 10 years. In practice, this means you need to have a substantial amount in savings to cover unexpected expenses or period without income e.g., due to unemployment.
Video Transcript – The choice between shares and bonds when building a portfolio
Most banks and other intermediaries offer a range of readymade investment portfolios with different combinations of shares and bonds. The more shares you have in your portfolio as compared to bonds the higher the risk. This is because bonds are debts, and they have to be repaid by the issuer company or government. Bonds only lose value in the long-term if the issuer goes bust. How to split your portfolio between shares and bonds depends on your risk appetite (how much risk you are willing to take).
In general, the longer time you are able to leave your money invested the more sense it makes to invest more in shares. So, if you are trying to collect money for the deposit of your mortgage and you plan to buy your first home in 5 years’ time, it is probably best to choose a fund with more bonds than shares so as to minimise risk and maximise the chance that in 5 years’ time your money will have grown in value so you can manage to buy your first home. But if you are investing to grow your wealth in a 20-year horizon (for retirement or to support your child when they grow up) then it is best to go for a fund with more shares than bonds as in the long-term shares outperform bonds. This is because historical experience from the US for instance shows that shares tend to give you twice as much return on average in a 10-year period than bonds.
In general, if you invest an amount of money today in shares you can expect it to double in value in around 7 years whereas if you invest it in bonds, you can expect it to double in value in 12 years. This does not mean that it will actually happen, as this is based on past evidence. If there is a World War III within the next seven years shares bought today are unlikely to double in value.
Video Transcript – Passive vs active investment
In investment, there is a choice between investing passively in a fund that typically spreads your money across many different companies and trading actively in shares and bonds. In the latter case, you can choose to put all your money in the shares of one specific company, for instance, and sell it at any time. Active investing like this is a very bad idea for the vast majority of investors, unless you have a lot of money and great expertise in business (e.g. you are Warren Buffet). Even for expert investors, statistical studies over many years show that active investment in most cases is not worth it: long-term returns tend to be very close to the returns of passive investment.
You may be tempted to pay your bank or an investment firm for investment advice to help you invest your money in a “smarter way” and achieve higher returns. While this is your choice entirely, and some advisers can no doubt help investors make better choices, keep in mind that plain vanilla passive diversified investment in a standard fund offered by any bank (with the mix of shares and bonds depending on your risk appetite), is nearly always as profitable as any other option and you save the advice fees too.
The main advantage of passive diversified investment is the reduction of risk. With your money spread across thousands of companies from many different countries it is highly likely that it will grow in the long-term in line with the global economy. For young people in particular, it is a very bad idea to invest actively. Often this behaviour is similar to gambling and if you are affecting you should seek professional help.