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Thursday, November 6, 2014
The pros and cons of investing directly in shares - and why funds may provide a comfortable alternative
The Royal Mail flotation last year provided a wake-up call to the potential benefits of investing directly in shares, and some weighty companies have followed suit this year. Could this type of investment be for you? We have set out to help you decide (and offer an alternative for those worried about the risk of buying shares).
With the economy picking up again, more and more companies - including big names such as Saga, Poundland and TSB - have floated on the stock market this year. As many of these flotations are open to the public, it's a good time to weigh up the pros and cons of becoming a direct shareholder - and we also look at funds, which offer a way to invest with less risk involved.
Pros of investing directly in shares
Over the long term, shares usually outperform money held in cash or fixed interest (Government gilts). Research by Barclays found that if you invested for 10 years, in 90% of the 10-year time periods since 1899 you would have been better off in shares than in cash, and for 79% of the 10-year time frames you would have been better off in shares than in fixed interest. If the time period was 18 years, you would have had a 99% chance of outperforming cash and an 88% chance of outperforming fixed interest if you had invested in shares.
There are also plenty of examples of a jump in returns from flotations as demand pushes up the price. For example, when Royal Mail issued shares last year, investors saw the price increase by almost 40% on the first day of trading.
Please note: Past performance is not a guide to future performance.
Cons of investing directly in shares
But not all flotations result in a huge return overnight. Facebook shares were launched at US$38 in 2012, only for investors to lose almost US$10 a share two weeks later when they started trading.
Even when you get past the initial phase it can still be a rocky ride. For example, shares in supermarket giant Tesco fell by 16% on 12 January 2012 when it issued a profit warning after disappointing Christmas sales.
More drastically, holiday firm Thomas Cook saw its share price fall by nearly 70% in November 2011 after a string of setbacks including the cancellation of holidays to Egypt and Tunisia due to political unrest in the region.
As with much else in life, if you're prepared to take a risk and it pays off, you will reap the rewards - but there are no guarantees.
Why funds may be a comfortable alternative
Investing in a fund gives you the potential benefit of good performance with less exposure to the risks associated with investing directly in the shares of a handful of companies.
Funds pool investors' money and can use it to buy a broad spread of assets including shares, bonds, gilts and property, so they could include a large number of different investments.
Taking this collective approach offers several benefits over investing directly in a small number of shares:
Although the value of your investment can still fall, having a broad range of investments within a fund means you're not tied to the fortunes of one or two companies. This means that if one performs badly, it will have a smaller impact on your return. You may also find that whatever causes one company's share price to slide could be the very same thing that causes another company in your fund to perform well. Similarly if one asset class is not performing well, another may compensate for this poor performance.
Investing in a fund also gives you access to a professional investment manager. As well as benefiting from their experience and expertise, fund managers often have access to information and research about companies that isn't readily available to the public. This can give them an invaluable insight into how to invest your money.
It can also be more cost-effective to invest in the stock market through a fund. Invest directly in shares yourself and you'll pay dealing charges of around £10 every time you buy or sell. In a fund, these charges and the costs for professionally managing the fund are spread across all of the fund's investors.
One type of fund which may be worth considering is the Foresters Friendly Society Order Insurance With Profits fund. If you're interested in finding out more about this type of investment, why not take a look at our simple guide to With Profits savings.
Please note that, dependent on the investment conditions when you withdraw your money, you may get back less than you paid in.
This blog is intended to provide information, not financial advice, to help you make an informed decision about savings and investments. We do not offer financial advice. You should contact a financial adviser if you want financial advice. You may have to pay a fee for this advice.