Are you planning on making monthly savings? Or do you already have a nest egg? If you put a little aside here and there for a rainy day, you have that added buffer of financial protection right when you need it most.
But before that day comes around, or before you decide to spend your savings on something big which makes you happy … what is your money doing in the meantime?
Is it gathering dust in a bank account, picking up paltry interest returns which don’t even keep up with the rate of inflation? If you have loyally kept your nest egg in a savings account, you can rest assured that the banks are not simply sitting on it. Most banks and building societies make their money by paying you low interest rates, and lending money to others with higher rates. They also invest it in other things such as shares, commodities and alternative investments. Although there are strict rules since the 2008 financial crisis about how much of your money they can gamble, it is still a very widespread practice.
So how do the banks make money from your money? What is it that pays for those City salaries and lifestyles? And can you do the same with your money yourself?
Yes, you can. And it’s even more simple than you might imagine.
If you are comfortable taking some risk, investing some or all of your savings could be right for you.
Over the long-term, investing is more likely to make more money than saving. So how exactly do investments make money over time?
Buying at low prices during market downturns
Buy low, sell high. This is how many investors would like to make their profit. But how do they actually do this? How can you know when the right time to buy or sell is? Making money sounds great on paper… but how do these people do it in practice without losing their nerve?
As you can see from this graph, for some people the stress of investing means that they can make the wrong decisions, at the worst possible time. Market storms, known as “volatility” can be a shock for new investors.
Source: S. Klarman
Find out more about how drip feeding benefits investors during market volatility.
There is actually a really simple technique that many investors use to “buy low” correctly. They drip feed regular amounts of money into their investments using automatic payments. By doing this consistently, over the good times and the bad, investors can take advantage of the low prices during market storms or downturns.
There is another advantage to drip feeding as well, which is that it smooths out the ups and downs in your portfolio. Everyone likes to look at their performance graph and see a lovely straight diagonal line pointing towards profit. A wiggly line which looks more like the Rockies … not so reassuring. Drip feeding helps to even out those bumps. The official finance name is “Dollar Cost Averaging”, or “Pound Cost Averaging” for Brits. This is because it literally averages out what you buy and what it becomes worth. Over the long term, it can give a real boost to your returns.
You can also do this. Creating automatic payments or paying little and often into your investment plan is a simple way to build a good nest egg. If you would like to get started way, have a look at the different types of investment plan we can offer you.
Taking advantage of dividends and coupons
Investors look to buy for a low price, and sell for a high price (known as a “Capital Gain”), but did you know that profit is also made in the meantime? This is one of the juicier parts of investing, and a huge reason why investments can be so much more profitable than a savings account.
Dividends
When you invest in a company by purchasing a stock or share, you also get to take a cut of the profits. These are known as a “dividends” and are usually paid every season or “quarter”. These lovely perks mean that you share in the companies’ profits. Because shareholders own a part of a company, not a sum of money, and you share in the company profits, they are protected from inflation, which is another serious bonus to investing.
And… as you can see in this article, you get added tax benefits on your dividend profits with a Stocks and Shares ISA.
Coupons
If you are investing in a bond or corporate bond, you loan a lump sum of money to a government or business which is paid back later. In the meantime, you would be paid interest or “coupons” by the borrower - exactly like taking out a loan or a mortgage by the bank. Except that you are the bank - which sounds good, right?
Dividends and coupons can really add up over time. The riskier the investment, the higher the potential return. For example, if a bond is considered less likely to pay back the money borrowed (by a rating agency), the interest or coupons will be greater. With a Stocks and Shares ISA, you have additional tax cuts for interest earned on bonds.
So, how can you use your money to take advantage of dividends and coupons? There are a few options. You could select the funds yourself with a DIY Stocks and Shares ISA platform. The advantage of this is that you get to tailor the types of investments you want directly to you. The disadvantage is that it may be quite time consuming, and if you do not have much experience, you could be more likely to lose money. Another option is to go for a managed Stocks and Shares ISA, where a team of experts invest your money for you. All you need to do is choose how much to invest and your risk level. The rest is done on your behalf by an experienced team of investors – investing has never been easier!
You can also benefit from dividends and coupons by investing in funds. Funds are groups of investments which are pooled together and then divided into bits. It’s like having a bowl of fruit salad, instead of having just one piece of fruit. You get a bit of everything without having to spend a lot of money. Investing in a fund means that you have a lot of companies in your investment plan, without having to put down a hefty minimum investment. For example, with just £1, you could have more than 5,000 investments in your plan at Wealthify.
The magic of compounding
If capital gains (selling for a profit) are the blossoms of investing, and dividends and coupons are the honey made from the blossom … compounding is like finding the golden goose at the top of the beanstalk. Lots of people have said lots of things about investing, a common favourite is actually Albert Einstein. Not just a mastermind of psychics, the German-born physicist allegedly exclaimed compound interest as;
“…the eighth wonder of the world… He who understands it, earns it; he who doesn't, pays it.”
So, what is it? And are you the person paying it or earning it? Compounding is when gains such as dividends or coupons are put back into the investment pot, and so the pot gets bigger. As the pot gets bigger, so does the compounding. If you can imagine a snowball rolling down a hill and getting bigger and bigger and bigger over time, it is a similar concept.
Compounding is an extraordinary advantage for investors, without lifting a finger, your money makes more money. It’s like your savings have their own day job. The beauty of compounding is that you don’t even need large sums of money to enjoy the effects. Patience is everything.
There are so many fantastic examples of compounding “magic”. We like the story of Grace Groner. Mrs Groner lived a simple life in a small one-bedroom cottage in Lake Forest, Illinois. However, despite her humble lifestyle, upon her death she bestowed more than $7.2 million US dollars towards a scholarship programme. How? It was baffling to those who knew her.
It emerged that at the age of just 25 (and in the midst of the Great Depression in 1935) she had purchased three shares in her company Abbott Pharmaceuticals for $180. Then she did nothing, she probably forgot all about it. For the next 75 years she held onto the stock and the profits were reinvested again and again. At the same time, the company grew and the stock split. She held onto the stock over 13 recessions. By the time she was 100 years old, she held more than 100,000 shares totalling over $7.2 million. Compounding can feel like magic.
So how could you get your own golden goose and take advantage of compounding? Really simply, invest … and do nothing. Nothing. Invest in anything which has, for example, dividends and coupons – such as shares and bonds and ensure that they will be reinvested. This could include funds and is standard for all Wealthify investment plans. Then sit back as your nest egg snowballs.
How do I get started?
Entering the investing world is easier than you might think. With robo-investing platforms, like Wealthify, you can become an investor in just a few taps. All you need to do is choose how much to invest and the risk level that suits you. We’ll take care of the rest, including building your Plan and making adjustments when needed. Visit our product page to find what plan would suit you.
[1] https://www.thebalance.com/how-banks-make-money-315473
The tax treatment depends on your individual circumstances and may be subject to change in the future.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
