If you want to be a successful investor, there’s one question above all that you need to answer. And that is: why am I doing this? Discover how a clear investment goal can make all the difference. Article by Nick Green.
Everyone needs a reason to invest. If you don’t have a clear goal in mind when you set up an investment, you’re merely squirrelling money away like, well, a squirrel. Come to that, squirrels do invest their nuts with a goal in mind (getting through the winter alive), and if they happen to leave any acorns buried, those might grow into trees to feed future generations. See, even squirrels do inheritance planning.
But back to you, the human investor. If all you do is put money aside, choosing funds that look sort-of-suitable, you almost certainly won’t be getting optimal value. For a start, how can you tell if a fund is ‘suitable’ or not if you don’t have a clear idea what it needs to be suited for? You may already be investing with specific goals in mind – a holiday, a new car, your children’s education – but even if all you want is some extra financial security (see the squirrel) that’s still a clear goal. And what many novice investors fail to realise is that knowing your goals is essential if you want to choose the best kinds of investments.
Can you spot any of your current goals below? We take you through the types of investments and strategies that could help you deliver each one.
- Buying a home
- Having children
- Rainy day fund
- Raising your family
- Getting married
- A career change
- Starting a business
- A career break
- Leave an inheritance
1. Buying a home
Owning your own home should be a high priority, and one to achieve if possible in the first half of life. Entering retirement without being a home-owner is risky, as it puts you at the mercy of rising rents at a time when your own income is restricted. In addition, a home itself is an investment, usually increasing in value over time, and in retirement you can draw upon this value without selling your home, by using equity release.
There are many options for saving or investing for a home, with the main ones being:
Both give you a 25 per cent bonus from the government, though the Lifetime ISA lets you save more (and for longer) and so earn a much bigger bonus. The Lifetime ISA also lets you invest in stocks & shares, while the Help-to-buy ISA is a cash-only ISA.
2. Having children
If you think there’s so much as an outside chance that one day you’d like to spend your weekends waving baby toys, changing nappies and sleeping not at all, then consider saving up while you’re still young and carefree. A new baby generally means an instant drop in income, coupled with an increase in everyday costs. Kids are expensive long before they reach school age, so avoid getting into debt in those early years, build up a financial cushion before your first child is a twinkle in your eyes.
A person in their 20s might look to become a parent in their 30s, but life has a way of surprising you. Explore medium-term investments that won’t penalise you too much if your plans suddenly change. Options include:
3. Rainy-day fund
At any stage of life it’s important to have a fall-back reserve of money for emergencies – whether these are caused by unexpected expenses, enforced time off work, job loss or some other crisis. Ideally you should be aim for three-months’ worth of salary in savings, but any cushion is better than none.
Crises are usually unexpected, so you’ll need to be able to draw on your funds at short notice. For this reason, your best options will usually be cash. For example:
This is the big one. Your retirement may last half as long as your whole career (or even longer), so you need to think about what you’ll do for income. It’s never too early to start investing for retirement – in fact, the earlier the better, as compound interest over time is your most powerful asset here.
Your main sources of retirement income could be:
Of these, pensions will probably be the most useful and important for you. Make sure you understand how your pension works so you can maximise its investment returns.
5. Raising your family
Yes, we’ve already covered the immediate expense of having children, but what about later? Little ones soon grow into bigger ones – and that applies to costs, too. Your dependants will stay that way for around 20 years at least (so around the length of a typical mortgage) and over that time may cost a similar amount (in the UK the average cost of raising a child to the age of 18 is £227,000 according to the Centre for Economic and Business Research).
Funding education can be one of the biggest costs. Even state education comes with a lot of expenses, from uniforms and sports kit to school trips. Fortunately you can predict exactly when these costs will hit, since you know a child will start primary school at or near the age of 5, secondary school at age 11, and higher education at 18 or 19. You can therefore time your investments accordingly.
Your options might include:
- Five-year bonds
- Stocks & shares ISA
- Buy-to-let property (e.g. for higher education to provide accommodation for your child)
6. Getting married
There are many good practical and financial reasons to get married, as well as the obvious romantic ones. On the other hand, a marriage ceremony and celebration can be very expensive. According to Brides magazine, the average cost in the UK is now in the region of £30,000 (including the honeymoon and engagement ring). Though it’s possible to have a great day on a much lower budget, there’s no doubt you’re looking at a hefty expense.
Unless you’re a real Bridezilla or Groom Kong, you probably won’t plan your wedding ten years in advance. This means your best option may be a regular savings account over two or three years – and lots of economising. Another good tip is to request gifts of money from guests, rather than traditional wedding presents.
7. A career change
It may take you many years to work out what you really want to do in life. If you decide to re-train mid-career and pursue something that really inspires you, how would you manage financially? You may have to be able to cope not just with training costs but also with a temporary drop in your income before you find your new career.
This kind of goal is a medium to long-term plan, but contains an element of unpredictability too. An innovative finance ISA (or similar peer-to-peer products) may provide the right balance between high growth and accessibility. Bonds are also an option.
8. Starting a business
Why should you invest before starting your own business? Well, although you can fund a business by raising finance, it’s prudent to begin with substantial capital of your own. In fact your fundraising is likely to be more successful if you can demonstrate that you’ve committed a sizeable amount of your own money.
Stocks and shares are high-risk investments, but if you want the chance to build up funds quickly then a stocks & shares ISA offers the best opportunity to do so. Choosing the right funds can be a good test of your business acumen, and a dry run for the equally challenging task of handling business finances. Equally, this is a good reason to consult a financial adviser.
9. A career break
If you don’t want to change your career but feel you need to recharge your batteries, a career break or sabbatical may be just what you need. As an investment goal this is similar to a career change in terms of the challenges you face, but with important differences too. On the plus side, you won’t be paying the costs of retraining. However on the downside, you may harm your long-term career prospects and also any other long-term savings you’re trying to build up (such as your pension).
Investments to look at here may include:
- Innovative finance ISA
- Other peer-to-peer lending products
- A reserve of cash savings for emergencies
Breaks in pension contributions (as well as National Insurance contributions, affecting your state pension) can be the hidden hazard of career breaks, so factor these into your planning.
10. Leave an inheritance
If you’re a parent, then you’d probably like your children to inherit as much as possible from you – without necessarily depriving yourself in retirement! The good news is that unspent pension pots can now be inherited tax-free, so anything you haven’t drawn as income can be passed on to your beneficiaries. Note, however, that this doesn’t apply to annuities, which pay out according to their own rules.
One good tip is to move your pension fund into safer investments in your later years, to protect it from short-term volatility. You may want to set up lasting power of attorney to ensure that this can be done even if you're unable to handle your financial affairs yourself.
If you have other investments you want to pass on to your family (such as property, equities, bonds or cash) then these will form part of your estate and could be subject to inheritance tax. Talk to a financial adviser about estate planning so that by the time your family inherit from you, any tax bill is reduced to a minimum.