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Investing – Where do I start?

By Emeka Ajogbe - Topics: Belgium, Investments, wealth management
This article is published on: 22nd March 2019

Receiving a lump sum payment can be exciting, as it is not often that we have the opportunity to spend or invest a large amount of money at one time. However, if you are investing for the first time, it can be an intimidating step to take. After all, not everyone knows the difference between a share, a bond or a fund and the financial markets can seem like running a gauntlet if you do not know what you are doing.

Investing sensibly in stock-markets, rather than saving at the bank (particularly nowadays when you would be lucky to find interest rates above 1%), is an important means of achieving financial security, and, particularly over the long-term, returns are typically far higher than is achievable from holding cash.

That’s not to say that it comes without risks. Indeed, every fund or investment comes with a disclaimer that past performance is no guarantee of future returns, and this statement is indeed true. However, past results can be useful when reviewing how the fund or investment performed during a financial crisis or when the markets were buoyant.

MY CURRENT FINANCIAL SITUATION
Before you invest, it is imperative to first assess your overall financial stability. It is not usually appropriate to invest if you are in debt, for instance. It is recommended that you undertake a review of your current financial situation with a financial professional. This should include looking at your household’s current net income, expenditure and any debt (it is advisable to pay off debts such a credit card balances before investing as the interest rates for borrowing are likely to be higher than the returns you could achieve by investing). As investing should be a medium to long-term strategy, it is also advisable that you have an emergency or ‘rainy day’ fund that you can use should you need it. As a general rule of thumb, you should have at least six months’ expenditure set aside for immediate access.

HOW AND WHERE SHOULD I INVEST?
Once we have reviewed your financial situation, the next step is to consider how and where to invest.

There are two schools of thought when it comes to how to invest. Either take the plunge and invest the entire sum at once, or drip the lump sum in on a phased basis until it is all invested. Investing the money all at once will give you the best chance of benefitting from compound returns. However, if the markets drop significantly soon after you have invested, you may regret it, at least for a while. Drip feeding a lump sum by splitting it into smaller amounts is called unit cost averaging, so-called because you are trickling in the money over time and averaging the ‘price’ at which you buy your chosen investment(s). Depending on who you speak to, you will be advised to proceed one way or the other, or perhaps a combination of both. It also depends on how much you are investing. It is unlikely that any amount under €100,000 would be invested on a phased basis.

ADVANTAGES OF INVESTING THE ENTIRE LUMP SUM
Despite the risk that accompanies investing the whole lump sum in one go, research has demonstrated that the majority of the time, ‘going all in’ will outperform unit cost averaging. This is because it exposes you to the markets sooner, giving you more time to take advantage of compound returns. Research by a global leader in fund management, Vanguard, showed using historical returns, and a hypothetical portfolio that consisted of 60% stocks and 40% bonds, that in the UK, US and Australia, going all in usually outperformed the unit cost averaging strategy. There were only a few short-term periods during the deepest 12 month downturns where this was not the case.

Historically, markets have increased in value over time (which is great for growing wealth and making money) and Vanguard’s research showed that the lump sum strategy generated returns on average 2.39% higher than with drip feeding an investment in over twelve months. That does not sound like much, but when you take compounding into account, after just ten years the difference is quite staggering.

The table below illustrates how global markets have performed historically. As you can see, the positive periods far outweigh the negative both in performance and duration.

SOURCE: GFD, BLOOMBERG, GOLDMAN SACHS GLOBAL INVESTMENT RESEARCH

Markets typically trend upwards, so in most cases, if you were to wait and contribute using a unit cost averaging strategy, the markets will rise before you can invest everything. This means that you will be buying at a higher cost and attaining lower returns.

DRIP FEEDING MAY BE APPROPRIATE FOR SOME INVESTORS
Behavioural psychologists have long known that, for most people, the pain of losing money hurts more than the pleasure of making money when it comes to investing. This is clearly seen when markets are down and people tend to panic into selling, instead of waiting out the downturn.

Let’s say that you invested €100,000 and the next day, or week, your valuation dropped by 10%. What would your reaction be? Would you remain invested or take it all out as soon as possible? Someone who is risk averse or anxious about investing might prefer to invest via the drip in strategy to reduce any emotional discomfort that may arise from market volatility.

BRANCH 23

In Belgium, you have the opportunity to invest via what are known as Branch 21 and Branch 23 products. With Branch 21, you benefit from capital protection but usually a low return. With Branch 23, your capital can fluctuate in value but the prospects for growth are far greater than with Branch 21. Branch 23 is particularly tax efficient as you will not pay withholding tax on your returns, whereas there is withholding tax payable on interest from bank deposits, Branch 21 returns and on most directly-held mutual funds.

For more information on Branch 23 and its benefits, please click here

Article by Emeka Ajogbe

Emeka AjogbeIf you are based in Belgium area you can contact Emeka at: emeka.ajogbe@spectrum-ifa.com for more information. If you are based in another area within Europe, please complete the form below and we will put a local adviser in touch with you.

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