Two of the biggest myths about investing is that it’s always scary and is the same as gambling. Neither are true.
It can be daunting to put your money into the markets via funds or directly via shares, bonds or other investments, but that is often down to inexperience and a lack of confidence.
Once you understand the basics, making your first steps with investing needn’t be nerve-wracking like jumping off the highest diving board in a swimming pool. You should have the courage to jump straight in and buy a fund, share or bond with conviction.
Are you investing or gambling?
Gambling is about placing a bet on something you think might win, such as a certain team in a football match or a horse in a race. No-one really knows how they will perform on the big day and you’re simply guessing the outcome, hoping to get lucky.
Investing is different. It’s about buying a slice of a company, in the case of shares, or loaning money to a company or a government, in the case of bonds. Investment funds are typically made up of an assortment of shares, bonds or both.
Where you’re buying shares, bonds or funds, you can access a lot of information about them, such as the amount of money a company makes, its record of accomplishment and its strategy for growth. You can make informed investment decisions based on this information and use various bits of data to see if the shares or bonds are cheap or expensive.
What’s more, the starting point for most investors will be a fund that has investments across a spread of different assets, rather than directly investing in the stock market. By opting for a fund you’re outsourcing this work to a fund manager or a computer algorithm, depending on which type of fund you pick. A fund manager will do the hard work of assessing which stocks or bonds have better prospects than others, hopefully giving you more confidence in their success.
Risks of investing and gambling
It’s worth thinking about different investment types as being rungs on a ladder. At the bottom end is the lowest risk investment. The risks increase as you climb the ladder. Shares are near the top.
The position of funds on the risk ladder depends on what’s inside their portfolio. An ‘equity’ fund will contain shares and potentially a small allocation to cash or bonds. A multi-asset fund will have a mixture of shares, bonds and cash and potentially some commodities and property exposure.
Risk ladder: how different asset classes compare
It’s possible to work out the level of risk attached to an investment. For example, if you’re cautious, you might gravitate towards low-risk investments, such as government bonds from stable countries, highly quality company corporate bonds or companies whose products and services are in demand in both good and bad economic conditions.
Lower risks typically mean lower returns, and the opposite is also true. Certain investors like to take higher risks in the hope of achieving higher returns – they want to earn more money as compensation for risking their money on something that is either unproven or where there are clear obstacles for the investee company or government to overcome.
A higher risk company on the stock market might be a drug firm that is still going through the testing phase and hasn’t yet got enough proof that its treatment works. In contrast, other companies might have an idea how much they are going to make over the coming year because their customers are locked into long-term contracts. In this instance, one could argue they are lower risk investments because there is more certainty over future earnings.
When you buy a bond, you effectively lend money to the issuer, which is either a government or a company. They promise to give you a specific rate of interest each year over a fixed term and then repay the original price of the bond at the end of that period.
Certain bonds considered to be higher risk are ones issued by governments or companies where there is some uncertainty over whether they can keep up repayments. Lower risk bonds might be ones issued by governments in developed markets that have a long history of meeting debt repayments or companies with robust finances.
How can you spread risk?
The best way of spreading this risk is investing in a multi-asset fund that has a good mixture of investments across different asset classes. You can pick the right one for your overall risk level, but it means that your money will be spread between different type of company, countries around the world and assets. This means that if one investment doesn’t perform so well, it won’t have a dramatic impact on your overall investment pot. And if one area goes through a bad patch, you’ve hopefully got other parts of your portfolio still doing well and acting as a cushion. In addition, buying a diversified fund off the shelf can often be cheaper than building up that portfolio yourself and maintaining it.
Differences between investing and gambling
There are additional key differences between investing and gambling, such as how you make money.
With investing, you can profit from growth in the value of your investment, such as selling a share at a greater price than you paid for it. Investments can also generate an income for you, such as dividends from certain shares and funds, and “coupons” or interest payments from bonds.
You might be able to get some money back if an investment doesn’t work out as planned. For example, a share price might fall to a level that prompts you to sell – you would still get back some cash in this situation.
In contrast, it’s typically all or nothing with gambling unless you have an ‘each way’ bet.
It’s important to stress that investing is not risk-free, and the value of your investments can go down as well as up. If you understand the risks in advance, you should be able to tailor your investment decisions to your risk appetite and time horizon.
Disclaimer: These articles are for information purposes only and are not a personal recommendation or advice. How you're taxed will depend on your circumstances, and tax rules can change.
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Written by:
Dan Coatsworth
Editor-in-Chief and Investment Analyst
Dan Coatsworth is AJ Bell's Editor in Chief. Dan has been with the company since December 2012 and has more than 18 years' experience in the industry, following the markets and all things investing. He has a degree in Corporate Communications from Southampton Solent University.
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