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How do I invest?

Depending on how keen you are on getting stuck into portfolio construction, the difficulty of building your own portfolio can range anywhere from, “So easy, I literally don’t have to do anything” to, “This is impossible, I can’t believe I have to do all this myself – I don’t even know where to start”.

The aim of this post is to help clarify the different avenues through which investors can build portfolios, and to describe the mechanics of how you can actually start getting your money invested.

To get the easy bit out of the way, if you decide to invest via an IFA or an investment manager, actually getting your cash invested is incredibly straightforward – they’ll do all of the work for you. That’s what you’re paying them for. They’ll walk you through the process, build a portfolio for you, ensure the portfolio is appropriate for your risk tolerance, and monitor it on an ongoing basis. The portfolio is completely out of your hands. Of course, what shouldn’t be underestimated is that the fees you pay them for this privilege can be a big detractor from your future returns

If you use a robo advisor or you’re a DIY investor, then you’re able to save yourself some money on fees – which adds to your returns – but you’ll also have to figure some things out for yourself.

Working out your risk tolerance

 

For DIYers and those using robo advisors, the first thing you need to do is to figure out your risk tolerance. Robo advisors will assume you already know your risk tolerance and will build you a portfolio to match it, and DIY investors need to build the portfolios themselves that match their own risk tolerance.

Your risk tolerance is essentially a combination of your ability and willingness to take risk. Your ability to take risk is how much a loss in your portfolio would affect your financial goals, and your willingness to take risk is how happy you are to accept losses in the hope of longer term gains. In general, your risk tolerance is set at the lower of the two – someone with a low willingness to accept risk, but high ability would be a ‘low risk’ investor, as would someone with a high willingness, but low ability.

Your risk tolerance will drive your asset allocation, which is one of the most important determinants of your future returns, so it’s important to take some time over it and not to just stick your finger in the air.

This is where the risk-tolerance questionnaire comes in. A risk-tolerance questionnaire aims to quantitatively measure your risk tolerance. It’s usually a tick-box form of about 10-20 questions which ask you questions like, “By how much could the total value of all your investments go down before you would begin to feel uncomfortable?”, and, “When faced with a major financial decision, are you more concerned about the possible losses or the possible gains?”

If you use an IFA or an investment manager, then they’ll provide the questionnaire for you, and you just have to fill it out. If you use a robo advisor, then you’re expected to already know your risk tolerance and select it when asked. If you’re a DIY investor, then you’ll have to figure it out yourself.

Whether you’re using a robo advisor or you’re a DIY investor, it’s always sensible to at least try to estimate your risk tolerance before investing, rather than just assuming you’re a maximum risk investor because the nice linear ‘High Growth’ graph on your robo advisor’s website goes up the fastest.

If you have a look online, there are a number of free questionnaires online which you find after Googling ‘risk tolerance questionnaire’. Vanguard’s one often appears high in the search results, and they offer a pretty basic questionnaire of 11-12 questions, which will give you an idea of what sort of questions they ask. For most people though, it’s worth getting this bit of your investing journey right. Your risk tolerance will drive your asset allocation, which is one of the biggest determinants of your investing results. So making sure it’s as correct as it can be is, in my opinion, worth paying a few pounds for.

Finametrica is one of the UK’s most popular risk-profiling tools, and their questionnaires are often used by IFAs and investment managers to determine their client’s risk tolerance. They offer an online risk tolerance questionnaire to anyone willing to pay £30 for it, which means you’re able to have a similar risk-profiling experience as someone signing up to a traditional IFA or investment manager. In my view, £30 is a drop in the bucket to make sure your portfolio is invested appropriately. It also comes recommended by Pete Matthew, the UK personal finance guru and host of the Meaningful Money podcast (which is a must listen for anyone interested in personal finance in the UK). Anything personal finance related that Pete recommends is good in my book.

The link to Finametrica’s questionnaire can be found here. Needless to say, I don’t receive any commissions from people signing up, I’m not an affiliate of Finametrica, and I don’t have any incentive to recommend them. I recommend them because they’re good, and I believe people should have a good idea of what their risk tolerance is before starting to invest.

However, it’s also worth understanding that whilst completing these forms is an essential part of the investing journey, it’s not without its problems.

In reality, it’s almost impossible to accurately gauge a person’s true risk tolerance, because a tick-box form will never accurately capture a person’s actual behaviour in times of market stress – when it’s most critical that our risk tolerance is appropriately reflected. We might say we’re willing to accept a 40%-50% drawdown in the hopes of achieving higher long term returns, but when the inevitable crash comes and our retirement fund is cut in half, what we do in reality might be very different to what we said we’d do on paper.

Unless we’ve lived through a large number of big drawdowns and know how we reacted in all of them (no-one), then we’re all still guessing. But by completing a questionnaire, at the very least it forces us to imagine the scenario of our wealth being cut in half, rather than just assuming we’ll be able to stick through any drawdowns. The act of imagining our retirement pot being halved is better than a finger-in-the-air guess. But we still have to admit that nothing is perfect, and a questionnaire is merely a best-guess at what we’d be willing to bear in a crash.

So once you’ve completed your risk tolerance questionnaire and you’re happy that the results are a good reflection of your risk tolerance, it’s time to invest.

Robo advisors will do the next bit for you, and construct a cheap, usually ETF-based, portfolio to match your risk tolerance. That’s what you’re paying for – the convenience not having to select your investments and maintain your portfolio. Like a discretionary investment manager, you have no choice about the day-to-day investment decisions, as they’re all made for you by the robo advisor.   

DIY investors will need to both construct and maintain their portfolio themselves. So the first step on the investing ladder is to learn how to actually build a portfolio which will match your newly-found risk tolerance.

Getting started

 

By far and away, the vast majority of DIY investing is done through an investment platform. A platform is an online service that allows an investor to buy stocks and funds online, and usually allows the purchase of investments through tax efficient wrappers, such as ISAs and SIPPs. The investor is wholly responsible for selecting their own investments through the platform, and the platform acts as a ‘broker’ – someone who will buy and sell the investments on your instruction.

Some platforms charge an annual fee based on a percentage of your investments, some charge a flat annual fee. Some charge trading fees based on a percentage of trade size, some charge a flat fee. Some charge no fee at all (as long as you invest in the platform’s own products). Some allow the purchase of individual stocks, some don’t. Some have a number of tax wrappers available, some don’t.

As a result, the platform that best suits your needs depends on the type of investments you want to make. If you want to deposit a lump-sum and not touch it for 50 years, you’ll want a different platform than if you want to invest £100 a month. Similarly, if you want to pick direct stocks, then you’ll want a different platform to someone who only wants to invest in funds.

There are a huge number of platforms out there, and it can be really tricky to know which platform is best for you. It’s made more difficult with platform fees constantly changing, and new platforms being launched all the time.  

Luckily, the tireless folks over at Monevator have done most of the heavy lifting for us. They’ve compiled an excellent, comprehensive list of platform options, and split them by flat fee platforms/ percentage fee platforms/ and share dealing brokers. The tables detail each platform’s annual fees, fees per trade, entry/exit fees, and suggestions for what kind of investors the platform might suit. It’s also updated on a regular basis, so the information is never that out-of-date.

It’s a great starting point for figuring out which platforms might suit your needs, and narrowing down the list of possible options.

One thing that Monevator’s comparison table doesn’t look at is user reviews. For feedback on how the different platforms stack up, Which? provides details of customer reviews, which you can access after signing up for their one month trial for £1. You can also visit sites like Money Saving Expert’s forum or reddit for more community opinions.

Deciding on which platform to use is a very personal choice, and one which you’ll need to do a bit of research on, as I don’t know why or how you’ll be investing.

Once you’ve selected your platform, it’s usually a pretty easy process from then on out. It’s simply a matter of following the signup instructions on the platform’s website, submitting your KYC information (passport, proof of address, etc), and transferring cash from your bank account over to them.

What then?

 

At that point, you’re free to construct whatever portfolio you’d like. And that’s the fun bit.

Despite my preference for keeping things simple, building a portfolio can get quite complicated when you’re faced with an almost unlimited number of funds to invest in. This is why I’ve decided to avoid making any subjective recommendations on what you should be investing in this section of the blog, which is supposed to be about ‘The Basics’.  

For my thoughts on how best to construct a portfolio, I’ll be creating a section of the website which will show exactly what my portfolio looks like, along with a number of articles which discuss various aspects of portfolio construction and the reasons behind my investment choices. The articles are roughly titled at the moment, and are under the ‘What does your portfolio look like?’ section. They’re currently in note form on my computer, and will eventually make it to the website as I plough through the rest of my notes.  

For now though, the next post in this series is for those people who worry that the next crash might be right around the corner. It aims to answer the age-old question of, ‘Should I wait before investing?’

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Past performance does not guarantee future performance and the value of investments can fall as well as rise. The information on this site is provided for information only and does not constitute, and should not be construed as, investment advice or a recommendation to buy, sell, or otherwise transact in any investment including any products or services or an invitation, offer or solicitation to engage in any investment activity. Please refer to the full disclaimer on the disclaimer page.

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