Are you looking to invest a large lump sum, such as a £100,000 inheritance?
Keeping large amounts in cash savings often isn’t the best strategy, as inflation can erode its value and interest rates may be poor.
But what are the alternatives – and how risky are they?
Here’s how to weigh the pros and cons of investing in a substantial amount like 100K.
In this article:
Define your investment goals
There are many types of investments from shares to unit trusts, commodities and offshore investments. There are also alternative investments, which include physical assets like art or jewellery. Some may also be classed as ethical investments, where your money is used to fund activities you approve of.
Before investing your money, decide what your investment goals are. What would you like to achieve with your money? For example:
- Are you investing the £100k to generate income?
- Are you investing the £100k for growth?
Investing for income is when you invest a large sum, then make withdrawals of the growth at regular intervals. This approach may leave most or all of the capital sum untouched, or reduce it only slowly. A good example of this is a pension drawdown scheme. Buying rental property also counts as investing for income, though it works in a different way (the income being the rent you charge to tenants).
Investing for growth is when you invest a large sum (or a series of smaller sums) with the plan to withdraw a larger amount at some point in the future. One example of this might be saving up a deposit for a home, and another common example is simply saving into a pension. But there are many other reasons to invest for growth, such as university funds for children, or a fund for a career break. In each case, you lock the money away with a particular goal in mind.
Growth or income - how will this affect my investment strategy?
So if you are looking for the best way to invest for income, what should you do differently compared to someone investing for growth (or vice versa)?
This decision will affect the choice of assets in your portfolio. When you invest for income, you want a regular (usually quite predictable) amount of growth that you can skim off the top. This means choosing more stable, slow-but-steady assets that are unlikely to take sudden dips. Big drops in value work against your strategy, because if you take money out of a falling fund, it becomes much harder to recover the losses.
By contrast, if you're investing for growth, you can afford plenty of ups and downs along the way, provided you reach your goal in the end. This means you can consider much more volatile assets ('volatile' means they are more likely to rise and fall substantially in value over short periods). So the makeup of your portfolio will probably be quite different - we'll cover that in more detail below.
Define your risk appetite
Knowing what you want to achieve with your money, and when, will help you determine your appetite for investment risk and therefore what assets to invest in.
High-risk assets include stocks and shares. Those in overseas businesses or in emerging markets are classed as particularly risky. So why consider these at all? The rule of thumb is that higher risk = higher potential returns – just as a horse with odds of 20/1 has less chance of winning, but you stand to win more money if it does. Lower down the risk spectrum are shares in established companies. After than come corporate bonds, government bonds and buy-to-let property.
Your risk appetite isn’t really about your personal attitude to risk, but your ability to tolerate it in practice (which is why it’s often call ‘risk tolerance’). In other words, it’s about how much you can afford to lose, how important stability is in your life, who else relies upon you, how well could you recover from losses, how long this might take, and so on. So you’ll need to consider things like:
- Your age
- Your relationship status – are you the main or sole earner?
- Your wealth levels – how much could you lose and still be comfortable?
- Your dependants – do you have children or others you need to care for?
- Your line of work – is your job stable?
- Your future prospects – is your career likely to advance?
- Your home – are you a homeowner? How big an asset is your home?
- Other circumstances – e.g. will you inherit money in the future? What other expenses do you have?
For example, a self-employed writer in their fifties living in rented accommodation with three children would be considered to have very low risk tolerance – but a young, single IT consultant living in their own home with plenty of savings would have high risk tolerance. This is irrespective of whether or not each considers themselves to be a ‘risk taker’.
A financial adviser will take you through a questionnaire to determine your risk appetite in detail. Once you know this, you can decide how to construct your investment portfolio, and the proportion of high-risk to low-risk assets to include. Most portfolios include a slice of high-risk assets, as this is where most of the growth comes from. The higher your risk appetite, the bigger this slice will be.
Define your investing strategy
At the same time as considering your risk appetite, when deciding on the best way to invest your 100k, you need to consider your investment strategy.
Popular strategies fall into a few broad categories, the main ones being:
- Value investing
Value investors are the bargain hunters. They search the market for stocks that they believe are trading at a significant discount to their value. Value investing can be rewarding, but you’ll need to be in it for the long haul and put in the hunting effort and research. The most famous value investor is Warren Buffet.
- Growth investing
Growth investing is about looking for the ‘next big thing’ – like new technologies. It considers a stock’s current health and its potential to grow.
- Momentum investing
Momentum investing, or trend following, is where investors rely on patterns to guide their investment decisions. They look for stocks and securities with a good pattern of high returns (generally over three to twelve months), sell them when they peak, and avoid those with poor patterns.
Investment strategies can be passive or active. Active investing means taking a hands-on approach, where portfolio managers continuously monitor activity, and buy and sell to try and outperform the market. This requires a great deal of research and forecasting.
A passive approach involves less buying and selling, and therefore less risk. Instead, it relies on exchange-traded funds, mutual funds or unit investment trusts. Instead of trying to outperform the market, investors work to gain similar returns to the market benchmarks. Historically, passive investing has outperformed the active approach over the longer term, though both have their benefits.
Create a portfolio mix
A sensible approach to investing 100k usually involves creating a mixed or diversified portfolio. This means you invest in a combination of high and low-risk assets, and a blend of active and passive strategies, to manage risk and maximise returns.
If you picture your portfolio as a pie chart, each slice of the pie will be doing a particular job. For example, a relatively slim slice may contain high-growth, high risk equities, and this will hopefully generate some dynamic growth. A bigger slice might hold medium-risk shares, to provide more stable growth, while another hefty slice might contain bonds for stability. Generally you will hold some cash, too (as well as being stable, this is useful for paying management fees without touching your higher growth assets).
Rebalance your portfolio regularly
An important step which many novice investors overlook is a regular ‘rebalancing’ of their investment portfolio to stay in line with their risk appetite. Over time, a portfolio designed with a particular risk profile in mind may fall out of line with it, as some assets grow and others stagnate.
For example, suppose you have a portfolio that is 30% shares and 70% bonds. If the shares do well and increase in value, then after a few years the value of your portfolio may be 40% shares and 60% bonds. But this means that more of your money is now in higher risk assets. If your risk appetite hasn’t changed, then the wise thing to do is move some of shares growth into bonds, to achieve a 30:70 balance again. If you’re older, and your risk tolerance has reduced, then you might even want to move even more into bonds or cash, to reduce your exposure to shares.
One way to manage your portfolio in an easy and accessible manner is through an investing app.
Invest for the long-term
If you have £100k to invest, your best returns are likely to be over the longer term, such as 5, 10 or even 15 years. Although they require patience, long-term investments are typically less volatile and can pay off handsomely in the end.
Sticking with an investment for a good number of years will help you ride out market bumps, diversify your portfolio, benefit from compound interest, and pay less in trading fees and lower taxes. In short, it will give your £100k maximum time and opportunity to grow.
If you’re feeling ready to invest your money, get in touch with an IFA to discuss your options.
Alternatively, if you need a little more steerage in defining your investment and financial goals, you can learn more about what a financial coach is and how they can help you here.
If you found this article interesting, you might also find our article on whether property is better than a pensions for investing informative too.