F0A81E Mature woman, outdoors, gardening, carrying watering can, focus on flowers

Why don’t more people invest in stocks and shares Isas? The vast majority of Isa subscriptions made each year go straight into cash, even though interest rates are very poor. More than 15 years after Isas were introduced, the cumulative sums invested in stocks and shares products are still only roughly equivalent to those in cash.

Many investors are put off stocks and shares Isas by the the possibility of a loss, but they reckon without inflation. Psychologically, they prefer the large probability of a small real-terms loss in a cash Isa to the smaller probability of a large loss in an investment product.

I cannot do much about this powerful behavioural impulse, but hopefully I can help overcome another factor that keeps money in cash: bewilderment in the face of overwhelming choice and unnecessary complexity. Here are my four golden rules for stocks and shares investing.

1 Get it invested

If you are investing a lump sum, this is first rule of a stocks and shares Isa. It sounds blindingly obvious. Yet each year thousands of investors get as far as funding a stocks and shares Isa, only to leave the proceeds languishing. This is a sure-fire way to lose money in real terms: if you think cash Isa rates are bad, take a look at the rates fund platforms and stockbrokers pay on uninvested cash balances. One reason for not getting invested is that the market is volatile, or that some catastrophe might be just around the corner which will make everything cheaper. This is generally a poor excuse for inaction; if you are concerned that markets are volatile or falling, then set up a monthly investment plan. That way, you will get more for your money with each passing month, as shares get cheaper.

2 Think about yourself

Deciding what to invest in can be a surprisingly stressful process — one reason many people end up procrastinating. The choice of investments (and types of investment) can appear overwhelming. Many investment guides assume you have unlimited evenings and weekends to cogitate over such matters. The reality of most people’s lives is rather different.

One useful way to think about this is to compare it to gardening, and ask yourself how much time you are prepared to spend tending your patch. The simplest option — equivalent to a cactus on the windowsill, perhaps — is a tracker fund or exchange-traded fund that simply tracks a benchmark index. This is the approach I use for my own Isa. The next step up, best thought of as a patio garden, is to own actively managed funds, where managers try to beat an underlying index or achieve a target level of returns. You will have to expend some effort identifying one with a good track record who isn’t charging too much. Once you’ve done that, though, it should largely look after itself. Picking your own shares is more akin to tending a substantial garden; it will require careful monitoring and there will always be decisions to make.

Consider also how much volatility would keep you awake at night, whether you need income or capital growth, and how long you are investing for. Doing so will help inform what asset class you invest in. Shares with dividends reinvested have historically generated the best long-term returns. But equities are volatile, so to smooth out the inevitable bumps you will have to commit for some time, typically five years or more. If you are investing for less than that, it may be worth looking at a defensive fund where not losing money is the main priority; if you have a longer horizon, consider something like small-cap shares. These are riskier, but have generated superior long-term returns.

Reinvesting income means your investments will generate no income stream; an equity income fund gets around this problem, but there will be a trade-off in terms of lower capital growth (and the fund’s chargesmay also be taken out of capital, further reducing long-term growth). Bonds, issued by either countries or companies, are less volatile and risky but will typically generate lower returns. Commercial property generates steady returns, but buying and selling buildings is time-consuming and expensive – so funds that invest in them may not, in volatile times, be immediately able to return your money when you ask for it.

3 Diversify

If you invest £10,000 in one company and its shares halve, you have lost £5,000. If you split the investment between two companies and one of them halves, you’ve only lost £2,500. This is the essence of diversification. One of the great benefits of actively managed funds is that the manager should be taking great care to spread risks (indeed, European fund rules require them to do so).

Do not confuse diversification with owning dozens of investments, though. A portfolio with too many holdings will require more monitoring and often lack focus. Similarly, a fund manager’s 100th investment idea is unlikely to be as good as his first; there are plenty of funds with a couple of dozen holdings that have beaten ones with hundreds.

Owning a mix of bond and equity investments may be a worthwhile compromise; the idea being that equities generate growth but bonds reduce volatility. A rule of thumb is that the percentage allocated to bonds should be the same as your age, though your individual circumstances should always inform your decisions more than hoary old City adages.

4 Stick with it

The factor that will make you more money than anything else is the simple passage of time, thanks to the effect of compounded returns. Do not be tempted to interfere with this magical process by jumping in and out of the market; doing so is almost always a waste of energy. Rather than worrying about the global economy, valuations or interest rates, worry about the things you can control, such as costs and asset allocation. Once you have made your investments, leave them alone unless there is a strong reason to make changes: a fund manager leaves, a company has a massive profit warning, or your personal circumstances change.

Stocks and shares Isa jargon buster

Funds, unit trusts and OEICs

These terms are often used interchangeably, but for practical purposes they mean the same thing (an OEIC is an open ended investment company). The pool of investments is variable; it grows as new money comes in and shrinks as money leaves. Their prices are set once a day, and reflect net inflows and changes in the value of the investments. There is usually no charge for buying or selling units in funds.

Investment trusts

These are companies, whose business is managing a fixed pool of investments. They can borrow to invest, which boosts returns in a rising market, and pay dividends out of reserves. Investors buy or sell their shares in the stock market, incurring dealing charges.

Tracker or index funds

Unit trusts or OEICs that track an index. Their costs are much lower than actively-managed funds.

Exchange traded funds

Similar to trackers, except their shares trade on the stock market.

Inc and Acc

Income units (Inc) in a fund or ETF pay dividends as cash. Accumulating units (Acc) automatically reinvest them in more units.

AMCs, TERs and OCFs

The annual management fee (AMF) is the amount paid to the manager for running the fund, usually expressed as a percentage of its assets. The total expense ratio (TER) or ongoing charges figure (OCF) includes the management charge plus most other running costs. A typical TER for an active fund might be 0.75 per cent, for a tracker, expect to pay 0.20 per cent or less.

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