What’s covered?

  • Building an emergency buffer and managing your cash effectively
  • Importance of diversification
  • Benefits of a long-term approach

Capital at Risk: All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

When working out how much you can afford to invest, it pays to heed your grandparents’ advice and play it safe

When it comes to understanding the basics of saving, budgeting and investing, we can usually thank our grandparents for their sage advice. They were the ones who told us to prepare for a rainy day, to start saving as soon as you get that first job and to look before you leap. Although society has changed in many ways over the years, the simple rules of money have not.

For anyone investing for the first time, financial advisers often recommend you build up an emergency cash buffer of at least three months’ salary. This helps you account for those “what if” situations – if you become ill or are made redundant. It also ensures you won’t be thrown off course by a curveball, such as the washing machine breaking down or the car failing its MOT.

Now let’s get to the exciting bit. Once you have that emergency buffer built up in a savings account – or anywhere you can dip in and out of your cash as needed – and you’ve given some thought to how much you can afford to part with, you can think about investing in the stock markets.

But try not to spend it all at once. The misconception is you need to save thousands of pounds before you make that first investment. But what happens if you work hard to save up £5,000, invest it as a lump sum and the market tanks the next day? It will hardly encourage you to continue investing. In fact, that market dip might even tempt you to sell off your holdings in a panic. If that happens, you will likely end up with less cash than you put into the market in the first place.

The ideal scenario is to drip-feed money regularly and consistently into your investments – for example via a monthly direct debit – making sure it’s genuinely disposable income, i.e. money you won’t need for anything else. The beauty of new technology means you can invest as little as £1 or even the change from your daily coffee thanks to money apps and digital investing platforms, and over time you could build up a substantial investment without even realising it.

On to the next stage. You’ve saved, worked out a budget and decided to invest regular small amounts. Now it comes to choosing what to invest in. The longer you can afford to part with your money, the more you can afford to invest in riskier assets such as equities and commodities. If you have less time on your side before you need the cash back, you will have a lower risk profile and should consider less risky investments such as government bonds.

The golden rule of investment is to be diversified, which means spreading your money between different stocks and bonds or making sure the portfolio you choose has a wide selection of investments in it. This method lowers your risk, because if some securities dip, hopefully the performance of the others will balance out your return. And if you opt for an Individual Savings Account (ISA) to house your investments, any interest, income and capital gains you make are tax free. Another option is a General Investment Account, which has no limit on how much you invest, although it doesn’t offer the same tax benefits. It’s also worth checking how much trading platforms and fund issuers charge to trade, because fees will vary between providers.

Next, be patient. As our elders like to remind us, these days it’s all about instant gratification. The markets may move fast – and indeed may shift up and down every day – but experienced investors know they have to wait for years to accumulate wealth. And investors won’t benefit from the long term if they invest in January and sell their holdings to buy Christmas presents in December.

A longer-term and diversified strategy means there is less chance of your investments losing significant value and a lot more probability you will benefit from the wonder that is compound growth, where you earn interest not only on your original capital but also on the interest itself.

With investment, nothing is free from risk – even if you follow all your grandparents’ advice. But investing sensibly and keeping your specific goals and time horizon in mind will mean you’re much more likely to be an investor for life.

Checklist for how much you can afford to invest

  • Think about your future goals and how you plan to get there
  • Calculate your income and outgoings to start a basic budget
  • Build up an emergency cash buffer of a few months’ salary
  • Work out how much you could part with on a regular basis
  • Shop around for the best digital investing or trading platform
  • Make those first investments in a diversified portfolio
  • Add small amounts when you can afford them or as regularly as possible