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Portfolio building basics: how to get started

In this series of articles for novice investors, the FCA and The Week tackle the main issues that investors need to be aware of

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If you’re thinking of investing, be it for retirement or simply to try to make your savings work more efficiently for you, there are several things you will need to think about.

Am I ready to invest?

There are risks attached to all investments, and it’s important to be aware of them before committing your money.

If you’ve decided to make investments, it is important to establish first how much you can afford to invest. Questions to consider include: what is your personal situation in terms of debt? For example, if you have any debt with a high interest rate, the expected growth on investments may be outweighed by this level of interest.

Hear LBC's Ian Dale talks to a fraud victim about how he was scammed

What financial arrangements have you made for retirement? What protection do you have in place in the event of an unforeseen event (such as critical illness, job loss or even premature death)?

You’ll also need to consider how much appetite you have for risk. Investments can go down as well as up, so you need to think about how much you can afford to lose, as well as how much you might gain.

Rebalancing portfolio asset allocation. Business concept

Rebalancing portfolio asset allocation

Diversification

Your individual appetite for risk, the amount you can afford to lose and the time frame you wish to invest for are just some of the crucial factors in determining which investment is appropriate for you.

It’s also important to remember that investing in just one area can increase the risk you are taking.

For example, you may wish to invest in a company with which you are familiar. However, putting all of your eggs in one basket could lead to substantial losses if that particular company develops issues.

That’s where diversification comes in - the practice of holding a range of investments across a number of sectors, asset types or companies. By spreading your money, you lower the risk to your overall portfolio, by reducing the risk of all your investments falling in value at the same time.

To give a simple example, imagine you invest in an umbrella company and an ice-cream company. If the weather is rainy, the umbrella company will do well; and if it’s sunny, the ice-cream company will benefit. By investing in both companies, your pot as a whole is less vulnerable to fluctuations in the weather.

Diversifying isn’t a simple matter. As stated, your portfolio of investments should be based on your financial goals, the time you wish to invest for, your appetite for risk, how much you can afford to lose, and many other things. As a result, your portfolio might be completely different to those of, say, family members or friends.

For example, your portfolio might contain things such as UK shares, whereas that of someone with different needs and goals might contain things such as US shares and property.

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Funds

A fund is a bundle of shares, bonds or other assets selected by a fund manager. Bonds are fixed-interest securities offered as a way for companies or the UK government to raise money, by borrowing from investors.

One of the main benefits of a fund is that you invest in a diverse portfolio of assets (often with shares in 40 or 50 different companies, in a shares-focused fund), without having to choose and buy those shares yourself.

Funds that invest in shares and bonds are also usually quite liquid, meaning you can usually buy or sell units in the fund quickly whenever you want.

The fund manager will charge a fee for their service, often in the form of a percentage of the value of the fund - so whatever fee they charge will affect any returns you make on your investments. Remember, the fees will usually come out regardless of how well or badly the underlying investments perform.

Each fund will have an investment aim. This might be very wide-ranging (for example, to invest in shares in large companies in the world’s major markets), or more focused (for example, to hold shares in small UK-based companies). In many cases, the fund manager chooses which shares or other assets to hold and in what proportions: these are called actively managed funds.

Other funds, known as passive funds, track market benchmarks such as the FTSE 100 Index. This means that your investment rises and falls in line with the index. Passive funds typically charge lower fees than actively managed funds.

Buying a fund, rather than individual shares, will go a long way towards diversifying your portfolio, but there is more you can do. Funds will often invest in particular areas of the market, as mentioned. This means that if something happens that affects an entire market, you could see all or most of the shares in a fund fall at the same time.

You can protect against this by diversifying even further, across several funds covering different geographical regions and company types, rather than holding all your money in a single one. This doesn’t alleviate all the risk of investing but, hopefully, it should insulate you against short sharp shocks.

You might also diversify across different types of assets, including shares, corporate bonds, government bonds and possibly property. By holding a diverse selection of assets, you are likely to be better protected from market shocks.

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Scams

There are some types of investments that are not regulated by the Financial Conduct Authority (FCA). If they are not regulated, you won’t have access to the Financial Services Compensation Scheme (FSCS), nor to the Financial Ombudsman Service (FOS) should you wish to make a complaint or in the event of a firm going bust. You can check the FCA Warning List for explanations of the risks involved with different types of investment, and to find out whether a product is regulated or not.

Never listen to any offers of financial advice or investment opportunities presented by people who contact you out of the blue. After all, if an investment is so great, why are the salespeople resorting to cold-calling strangers? The chances are that any offer they make will be a scam.

Many fraudsters will include an element of time pressure in their offers, along the lines of: “This opportunity won’t be around forever and only those who get in quick will reap the best rewards.” They may warn against telling anyone else about the deal, perhaps saying the offer only stands on condition of confidentiality. Above-board investments will never have a condition of secrecy and very rarely come with time pressures.

Don’t underestimate how cunning these scammers can be. Some purveyors of dodgy investments will be equipped with answers to all your questions and arguments, including why your financial adviser might steer you away from what they’re selling. The best thing to do is simply not engage.

Consider paying for the services of a financial adviser: the Money Advice Service website has information on how to find a reputable one. You can also get further information from a group that represents advisers, such as the Personal Investment Management and Financial Advice Association (PIMFA). If you do employ an adviser, use the FCA’s Financial Services Register to check they are authorised.

So do your research: look into the different types of investment options and think about how much risk you can afford to take. Speak to an FCA authorised financial adviser if you want expert help, and visit www.fca.org.uk/scamsmart to find out how to protect yourself from scams.

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