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Sow today, harvest tomorrow: ten guidelines for long-term investing

Learn how to reap the benefits of investing from a young age with these ten quick guidelines

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As we are all living longer, it's never been more important to build up a solid nest egg for the future. It might seem a long way away if you're a young, first-time investor, but start investing in your twenties or thirties and you'll reap the benefits in years to come. Here are ten guidelines to consider when investing for the long term.

Use a tax wrapper like an Isa or pension

The first home you may wish to consider for your savings might be a tax-efficient one, such as an Isa or a pension, depending on what you’re saving for. From April 2015, you can save up to £15,240 tax-free in an Isa, and split it between cash or stocks and shares, in any way you'd like. As part of a long-term savings plan, an Isa could be considered alongside a pension, which will offer tax relief at the marginal rate on contributions. Isas are more flexible and the money isn't locked away, while money in a pension can currently only be accessed from age 55.

Major reforms that came into force on 6th April 2015 will allow pensioners flexible access to their cash at aged 55. The first 25 per cent can be withdrawn tax free as normal, savers are free to access the rest of the cash when they like, whether it’s all at once or gradually, but it will be taxed at marginal rates, so taking a larger lump sum could push you into a higher tax bracket. While the freedom is welcomed, it's important to consider how much you draw from your pension; if you draw too much too soon, there's a risk your money won't last into later life.

Reinvest your income

The longer you leave your money, the more you'll earn. In fact, if you invest £100 a month, starting at age 35 would mean a pension pot of £88,040, but start at 25 and this rises to £160,569 (this example assumes an initial investment of £1,000 with an average return of 5 per cent a year with income reinvested each month and a retirement age of 65). Go here for more information

If possible, you should reinvest the dividends you receive from an investment back into your portfolio, which means buying more shares in the same stock or fund which will help build a greater base from which your savings will grow. This has a cumulative effect and so the value of your investment should rise much faster than if you take the dividend as a cash payment and hold the same number of shares.

Consider an investment trust

Like actively managed open-ended funds, investment trusts are usually sector specific and are overseen by a fund manager, who will make decisions about when and where to invest. Unlike open-ended funds, they are structured as a limited company, so they are traded on an exchange and the number of shares in issue are fixed.Annual charges tend to be much lower than open-ended funds. Many have ongoing charge ratios of less than 0.75 per cent. Additionally, some have a record of increasing dividends each year by 'smoothing' returns over the long term. 

Check long-term past performance

A well-known investment warning is that “past performance is not a guide to future returns”. That said, there are a number of funds out there with solid three, five and seven years and enjoy a reputation for good long-term performance. The important thing to note is not to get too hung up on short-term performance as markets will have periods of volatility. Depending on what you'd like to invest in, you can check fund statistics through services such as Trustnet and Morningstar, which rank all types of pooled funds and trusts by sector and performance.

Understand what you've invested in

Most investment houses publish fund factsheets that identify at least the top 10 stocks that a fund will invest in. Some go a step further and publish all the underlying holdings. You might consider investing with a firm that takes a transparent approach to investment, as it means you'll understand exactly where your money is going. This is important if you feel strongly about a certain stock or issue, particularly around ethical and sustainability issues. 

Understand your time frame

Consider how long you'd like to invest for and what your goals are. Short term usually refers to holding an investment for under one year, medium term between one and five years and long term is anything over five years. If you're investing for the long term – perhaps into a pension – consider taking a little more risk with your portfolio, as the longer time frame will help smooth out any bumps in the market.

Read more about risk and return here

Consider long-term investment themes

The world we live in is changing, and a growing population requires more resources such as food, energy and good-quality healthcare. Investing in these sustainability themes ensures that you are investing with the changes in society, and your money will potentially benefit you as well as the world around you. Over the longer term, investing in long-term sustainable themes could also deliver better returns.

See five companies that typify sustainable business here

Diversify your portfolio

The golden rule of investment that you might wish to follow is never to keep all your eggs in one basket. By investing across a spread of assets – including cash, bonds and equities – that are generally uncorrelated to each other as part of a well-defined asset allocation plan, your return will typically be a smoother and more solid ride over the long term.

Consider a DIY investment platform

If you feel confident enough to go it alone with your investment portfolio, consider a DIY fund supermarket, for example Alliance Trust Savings.. These low-cost, convenient platforms allow you to decide independently on the level of risk you'd like to take, and buy pooled funds and trusts as well as individual stocks and shares. Otherwise, you could seek out the advice of an independent financial adviser, who can guide you on the best route for your portfolio. You can still benefit from investing via a platform, either directly through your adviser or after taking their advice, but of course there will be additional costs associated with this.

Check the costs of investment

It is wise to be aware of fund charges, as when accumulated they can eat into your returns. Collective funds will levy an annual management charge, typically under 1per cent a year, and some might have a performance fee that kicks in if the return reaches a certain level. The fund factsheet and website will usually list the charges as the Ongoing Charges Ratio (OCR). The lower the OCR, the more money you will have in your pocket when you come to access your investment gains.

For more on understanding long-term investment, click here.

Illustration by Sue Macartney-Snape for the Daily Telegraph.

Important information

Always remember, your investments can go down as well as up and you may get back less than you originally invested. 

Alliance Trust does not give advice. You need to ensure that you understand the risks and the commitments before investing. If you are unsure, do consult a financial adviser

Laws and tax rules are not guaranteed and may change in the future without notice. The information provided here is our understanding as at March 2015. This information takes no account of your personal circumstances which may have an impact on tax treatment.

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