How investing works
Deciding how to invest is a daunting task, and one that can paralyse even the most ambitious amateur investor.
Although there are different ways to do this (see below), the principle of investing remains the same: allocate money in the expectation of making profit in the future.
This article is intended for those prepared to take at least some risk with their money and invest for more than five years. If that's not you, you may find this guide more useful.
Here, we explain how to build and manage an investment portfolio.
How do I buy investments?
If you decide to invest without the help of a financial adviser, you can cut the cost of investing by using an investment platform (sometimes referred to as fund supermarkets) or investment broker.
Investment platforms are online hubs that allow you to buy investment products and monitor their performance in a one-stop shop.
Because you're doing all the hard work of picking your investment, you won't be paying the fees associated with going through a financial adviser. Cutting these charges can have a significant impact on the performance of your investment portfolio over the long-term.
Some investment platforms now offer ready-made portfolios designed for different risk appetites.
We've reviewed all the major investment platforms and named a handful as 'Which? Recommended Providers'.
- Find out more: the best and worst investment platforms
The Which? investment portfolios
As a DIY investor you should already have a clear idea of your investment goals and timeframe, and how much risk you want to take on (your ‘risk appetite’).
We’ve built a set of investment portfolios designed to illustrate how you could spread your money across several types of investment, or asset classes, depending on how much risk you are willing to take on and how much growth you hope to attain.
You can find a full list of asset types and associated risks here.
Each different type of investment carries a level of risk. The riskier the asset, the higher the potential return - and greater the potential loss.
If you’re already invested, take a look to see if the portfolio best suited to you matches the make-up of your existing portfolio. It’s possible you could be taking on too much or too little risk without realising.
We've given our portfolios a spicy theme - the hotter the chilli, the riskier your portfolio is going to be. But those riskier portfolios also have more potential for growth.
These portfolios don't constitute financial advice, but can act as a helpful starting point for a conversation with a financial adviser.
The portfolios are built for long-term growth - you'll need to invest for at least five years - and not designed for those looking to get an income from their investments.
How do I choose investment products?
The next step to take once you've decided on your ideal portfolio will be how to populate it with actual investments.
They're cost-effective, and allow you to further spread risk, compared to investing directly in shares. Remember, the management costs of your investments can have a big impact on their performance.
We suggest you use low-cost tracker funds to fill up your portfolio, although some assets, such as property, may be better suited to higher-cost, actively managed funds.
- Find out more: active vs passive investment
Should I drip-feed or invest in lump sums?
Your approach to investing ultimately depends on your own risk appetite. A more cautious approach would be to wait, and only buy investments when the market enters a sustained recovery.
But this means you could miss out on market growth. If you’re worried about being exposed to a sharp downturn, you can cushion the effects by regularly investing smaller amounts each month, known as ‘pound cost averaging’.
This spreads out your purchases across periods when the market is high and when it’s low, averaging out the cost of the investments. And if the market falls, you’ll benefit from knockdown prices and be able to buy more units for the same price.
However, as drip-feeding your money means it’s invested for less time than if you invested it in one go, you won’t benefit as much from any gains.
In theory, the riskiest tactic – with similarly high potential for reward – is to invest a lump sum. You’ll take full advantage of any recovery, but will be exposed to any falls. Historically, markets have risen more than they’ve fallen, meaning that lump sum investors have benefited more.
- Find out more: lump sum or regular savings?
How do I rebalance my investment portfolio?
It’s possible that your priorities or risk appetite may change, and your portfolio might need to be altered to reflect this.
But generally, you'll need to re-assess and rebalance your portfolio annually. Rebalancing involves selling or buying assets, returning to the original proportions and ensuring you’re not taking on more risk then you thought you were.
This is necessary because, over time, your investments may fall out of sync with your original asset allocation; this tends to happen when one asset, usually equities, grows more quickly than the others.
Imagine you had invested in line with our low-risk ‘Jalapeno’ template portfolio. After five years, the whole portfolio had grown, but emerging market equities (which are higher-risk) have grown faster, meaning they represent a larger proportion of your portfolio, making the portfolio riskier.
You'd need to sell some of your emerging market equities holdings, and reinvest the cash in the other sectors, to return your portfolio's original proportions.
Poorly performing investments
Generally speaking, you would also check how your investments are performing and consider selling long-term underperforming assets.
But don't panic sell - this is likely to do more harm than good, as you’ll realise losses and miss out on any recovery.
Try to resist the temptation to tinker with your portfolio; instead aim rebalance after six months or a year. An increasing number of investment platforms now offer smartphone apps, but these can increase the temptation to tinker.
The Money Advice Service has some advice on assessing the performance of your investments, although this should not be taken as financial advice.
- Find out more: investment platforms reviewed