DIY investor toolkit: three tests to pass before starting investing

Various surveys over the years regularly cite 'a lack of knowledge' as the number one reason why people choose the relatively safe option of cash in the bank ahead of putting their money to work in the stock market.

As part of a new series, 'DIY investor toolkit', Money Observer will be offering a helping hand for those who are thinking about investing for the first time, or who have relied till now on a professional adviser but want to start making their own decisions.

We will deliver a mixture of jargon-free content to help you get started, from practical tips on how to decide which broker to pick to ideas on how to construct and manage your own portfolio.

For more tips and pointers to investing in the stock market, visit our Beginner's Guides section.

But first we will run through whether you are in a position to become a DIY investor. Going down this route involves forgoing financial advice and selecting your own investment funds.

Financial planners stress that anyone who wants to invest should pass the three tests below before making their first foray into the stock market.

EMERGENCY FUND

Everyone should have some 'rainy day' money for emergencies. Ideally an emergency fund should aim to have three months' salary in cash.

As things stand today, spreading money between various types of high-interest current accounts is seen as the best approach to make your money work harder, rather than settling for the pitifully low rates of interest available on deposit.

But one thing to bear in mind is that there are restrictions on the amount of money that can be tucked away.

The top payers, offering 5 per cent, are TSB and Nationwide. But the maximum threshold for each account is £2,000 and £2,500 respectively.

Therefore to receive the higher rates, savers will need to open multiple accounts and set up a system in order to meet the minimum monthly payment that needs to be paid to receive the interest.

CLEAR DEBT

It is important to have rainy day savings, but it is normally not a good idea to prioritise additional savings over reducing debts such as outstanding credit card balances or personal loans, simply because debts usually cost more in interest than savings earn.

Those who have several debts should tackle the most expensive one first.

INVEST FOR AT LEAST FIVE YEARS

For those who will need access to their money in the next couple of years, it is best to stick to cash, because over short time periods the stock market can be pretty unforgiving.

But over longer periods the odds of losing money decrease, as shown by research last year by Woodford Investment Management, which looked at the probability of making money from the UK stock market over different time frames since 1965.

It found that investors who buy and hold for 10 years had a 99.4p per cent chance of making money. Over five years the percentage chance of success was 92.8 per cent, over one year it was 82.1 per cent, and over a one-month period the probability was 63.9 per cent.

It is worth pointing out, however, that this analysis did not take into account inflation or charges.

Advisers recommend a minimum investment period of five years.

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