Investing for Dummies – UK - Levene Tony

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      Investment hasn’t had a good image recently. It started with the Northern Rock disaster back in 2007, where small investors in what should’ve been a rock-solid business saw their shares go down to the very hard place of zero. Northern Rock was only the beginning, followed in the subsequent year by the collapse or near-collapse of some of the UK’s and the world’s biggest banks, and their subsequent rescue with billions of pounds of taxpayers’ money. The media can characterise anything to do with finance – the City of London and New York’s Wall Street especially – as greedy, self-serving and even a threat to the planet. And yes, a lot of that’s true. Investment bankers have paid themselves bonuses to equal the earnings of football internationals and Hollywood stars. Since the banks started collapsing, scandal after scandal has ensued, with bankers accused of rigging just about anything they can get their hands on, including interest and currency exchange rates. Many global banks have been fined sums hitting billions. Somehow, unlike footballers or actors, they manage to pick up huge wage packets for failure, or unbelievable ‘severance packages’ should they actually be forced to quit. After all, hardly anyone else, and certainly not their bosses or their shareholders, has a clue what all their esoteric investments are about.

      And when serious professional investors fell for Bernie Madoff’s $50 billion investment scam, you seriously had to wonder what it was all about. Madoff ran what seemed to be a very successful fund, although it turned out to be a Ponzi scheme. Named after 1920s swindler Charles Ponzi, these plans offer very high returns that they can only give to investors by using new money coming in to pay out anyone who wants to withdraw. When the new money stops or is slowing, the whole house of cards collapses. The scheme invests in nothing – other than the promoter’s secret bank accounts.

      We’ve yet to come up with anything to replace the financial system we have at the moment, but the great crash should teach us some lessons. Firstly, never, ever take even the supposedly biggest and brightest investment brains on trust. Secondly, although no one will again fall for the mess of offering complex financial instruments and dodgy mortgages to people who had no hope of ever repaying, other financial bubbles will occur in the future. There’ll even be those who claim to have learned from the mistakes and who come up with an even better way of packaging these home loans.

      So when it comes to your hard-earned money, never sleepwalk your way to ruin. As the old saying goes, ‘if it looks too good to be true then it almost certainly is’. No safe route exists to a quick buck; highly paid City types eventually run out of luck; guarantees given by the seemingly most august banks can turn out to be worthless; and you can’t even rely on governments to always back their promises.

      Look out for the warning signs. Shareholders in Northern Rock, Bradford & Bingley, Halifax Bank of Scotland and Royal Bank of Scotland had plenty of chances to get out with something before the shares went down to zero (in the case of the first two banks) or down to pennies (with the second two), before government-sponsored rescues. Warnings were spread over a number of months.

      So why did so many private investors ignore the signs? For some, their holding was so small that selling would have cost more than it was worth. But most had an irrational hope that things would get better and go back to ‘normality’ where prices keep rising. If the global financial crisis that started in 2008 has taught people anything, it’s that ‘normality’ includes disastrous crises as well as good opportunities.

 Five Basic Investment Choices

      All your money decisions, outside of putting your family fortune on some nag running in the 3:30, simply involve making up your mind as to where to put your money. Literally tens of thousands of choices are available online. And at least a thousand choices appear in many daily newspapers.

      But you can cut that number down to just five possibilities by considering basic investment choices only. Get these right, or even just right more often than wrong, and you’re well on the way to financial success:

      ✔ Cash

      ✔ Property

      ✔ Bonds

      ✔ Shares

      ✔ Alternatives

      

Here’s a big investment secret: most professional fund managers – yes, those City of London types who pull in huge salaries and even bigger bonuses for playing around with your pension, savings or other investment money – don’t wake up each morning asking themselves which investments they should be buying or selling that day. Instead, they reduce the investment world to five big buckets that they call asset allocation, which simply means that they divide up investment money into the five areas in the preceding list – cash including foreign currencies, property, bonds, shares and alternatives. They take your money and allocate a portion to shares, another portion to property and so on. The fund managers, and especially the people who run large pension funds, know that if they get their asset allocation decisions right and do nothing else, they’ll beat the averages over the long term.

      Can this theory fail? Yes, especially over the short term, by which I mean up to two or so years. In the great global financial crisis, almost everything went down. You couldn’t just move from one thing to another because whatever you switched to was equally under pressure. No single investment theory works all the time. The best I can do is to point you to those that have a good chance of working most of the time.

       You can’t go wrong with cash

      Having cash under the mattress can be very comforting when everything is going wrong in your life. But keeping cash under the mattress, or anywhere else at home, isn’t a good idea from a security point of view. Nor does it make sense for investors. Putting your cash in a bank protects it from thieves, fire risks, and perhaps the temptation to grab it and spend it in a shop.

      

You never earn much money just leaving your cash in the bank. Most bank account money is in current or cheque book accounts, which often pay just 0.1 per cent, an interest rate that, transformed into pounds and pence, gives you the princely sum of £1 for each £1,000 you have in the bank for a full year. And if you’re a taxpayer, that £1 may be worth as little as 55p after HM Revenue & Customs take their slice. Ouch!

      Better ways of investing the cash that you don’t want today are available, including building society deposit accounts, online cash accounts, telephone banks and postal accounts. With all these options, you can get a higher interest rate but you have to give up flexible access to your cash in return. And you won’t make much. Since interest rates hit their lowest ever in March 2009, savers have struggled to get anything much, losing out to rising prices. But the situation won’t always be like that.

      

The longer you’re prepared to tie up your money, the better the rate of interest you receive. You can lock into fixed rates so you know exactly where you stand, but you must be prepared to hand over your money for a set period, usually one to three years, and throw away the money box key. Granted, some fixed-rate deals let you have your money back early, but only if you pay a big penalty.

      Whatever you earn is cut back by income tax on the interest unless you’re a low earner or use an Individual Savings Account (or ISA). But does this matter? No. The best you can really hope for from a cash account is that the interest equals the rate of inflation – that’s the amount the price of things the average person buys goes up each year – after the tax charge on the annual interest uplift. If inflation is 4 per cent, then a 20 per cent taxpayer needs a 5 per cent headline rate to keep up with price rises – work it out and see! Suppose, for example, your savings account of £1,000 earns £50 interest, or 5 per cent, in a year. Take off the basic rate of tax (20p in every pound) and you end up with the £40, or 4 per cent, you need just to keep up with the rate of inflation. If you’re well off enough to pay

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