How to start investing

Balancing cash, investments and pension pots

Our reader should maintain her saving accounts, Isa and company pension when she starts investing. Cash is necessary for emergencies and you also need to save for a pension, which is likely to be boosted by your employer if you have the option of a company scheme.

"For most people in this situation I would suggest keeping some money available in cash, and pay into a company pension scheme and stocks-and-shares Isa," says Patrick Connolly, chartered financial planner at Chase de Vere.

Isas are generally the most tax-efficient way of holding your money, but the personal savings allowance, which gives everyone £1,000 of tax-free interest on savings from this year, makes savings more tax-efficient. Our reader could leave her cash in a current account or savings account with a good rate of interest, and take out a stocks-and-shares Isa for her investments in stocks, shares and funds.

Mr Connolly says: "The personal savings allowance should be enough to incorporate all or most of the interest this reader earns on their current level of savings, and means they could give priority to a higher-interest savings account."

If you cannot bear the thought of locking your money away for the long term or think you will need to access it sooner than in five years, keep more in cash. Generally planners advise holding three to six months' worth of your salary in cash for emergencies, but this will vary depending on your risk appetite and your short-term needs.

On top of cash for emergencies you should add any cash to cover short-term spending. Danny Cox, chartered financial planner at Hargreaves Lansdown, says: "Beyond this it depends on your objectives. Most people will have a mixture of short, medium and long-term money, and the type of asset chosen will depend on these goals and the amount of risk you wish to take."

However, Adrian Lowcock, head of investing at AXA Wealth, says given our reader's fairly short time horizon, she should hold around two-thirds of her money as cash. He says: "It's worth shopping around for the best rates cash accounts can offer, and even tying the money up in one- or two-year bonds where the interest rates are more attractive than instant-access accounts.

"If you need the money sooner the most you will lose is some interest on savings, but you are unlikely to be worse off given instant-access savings accounts offer paltry returns."

Higher-risk investments

Over the long term stock market returns should typically outperform cash.

"Over the past five years, global stock markets have returned on average over 8 per cent a year. This compares very favourably with cash savings rates, which have typically been sub 1 per cent," says Michelle Pearce, chief investment officer at Wealthify.

You can hold a stocks-and-shares Isa alongside a cash Isa, but remember your annual allowance remains £15,240 in total - you cannot exceed that in both Isas combined.

A do-it-yourself (DIY) investment Isa bought on a platform such as Hargreaves Lansdown or AJ Bell allows you to choose a wide range of funds, stocks and shares, unlike a fully managed investment Isa where you buy an off-the-peg portfolio, often composed of passive funds. If you want to make your own decisions, opt for the former.

When deciding which stockbroker or fund platform to buy your Isa from, look carefully at the fees. Most charge an annual fee, and then levy a fee each time you want to buy or sell an investment. These vary dramatically depending on the amount of money you have in your portfolio and the amount you deal, so make sure you select the right one. For more on this, take a look at our recent articles on subjects such as how to buy a cheap DIY Isa and Isa charges.

A good option for young investors unsure whether they will be able to buy a house in the near future, but still keen to save, is the Lifetime Isa (Lisa). This will be available from 2017 to people between the ages of 18 and 40. You can invest up to £4,000 a year into a Lisa and the government will add £1,000 to that sum at the end of the year. Money can be withdrawn tax-free to pay for a first home, but otherwise must stay in the account until the age of 60 or face exit penalties.

Setting a time horizon

The longer you can lock your money away, the more risk you can take with your investments. Jason Hollands, managing director at Tilney Bestinvest, says: "Five years is really the minimum period you should have for most types of market investments. Unless your reader has that length of time she should stick to cash and accept that she won't make much return."

"To be a truly successful investor you should try to think of investing over decades," adds Mr Lowcock.

How much you should invest each month will depend on how much money you need to live on, and your calculations about how much you want to hold in cash and investments. You could decide to commit money each month to both your cash and savings accounts or, if you feel you have enough in cash, drip-feed money into your investments each month from your disposable income.

Putting money into your investments each month, rather than in sporadic lump sums, is a good way to invest as it enables you to ride out some of the highs and lows of the stock market. You benefit from pound cost averaging whereby you sometimes buy shares at market peaks, but at other times are able to get more for your money by buying when the market has fallen. This means you don't need to time the markets and it is also a good strategy for investors starting out, as you can build up a pot over time.

Our reader could transfer half of her cash Isa into a stocks-and-shares Isa, or start a stocks-and-shares Isa by paying in some money from her salary each month.

Asset allocation

One of the important things to do when you are investing is to spread your risk out by not concentrating all your money in a limited number of stocks. "Taking a stockpicking approach leaves your savings tied to the fate of a small number of companies," explains Ms Pearce. "This is great if you pick well, but is notoriously tricky to do."

For this reason she recommends investing in funds, as does Mr Lowcock. "Funds are a good way to get a diversified portfolio quickly and without too much cost," he says. "They allow you to pool your money with other investors and then a professional manager decides which companies and investments to buy."

The lowest-cost type of fund is an exchange traded fund (ETF), which can be obtained for an ongoing charge as low as 0.07 per cent.

Shaun Port, chief investment officer at online wealth manager Nutmeg says: "Given your reader's timescale of up to five years, we would suggest quite a cautious mix of assets for her investment portfolio." He recommends the following breakdown:

Mr Port says this could be done by allocating as follows to these funds:

Ms Pearce suggests the following allocation:

If you prefer to take less risk with your investment plan, Ms Pearce says you should stick to more established and developed countries such as the UK, US and Europe, which tend over the long term to have steadier returns.

"For a moderate risk investor these should make up the bulk of the shares in your portfolio," she says. "However, you could complement this with small positions in what are traditionally considered riskier areas. You could either pick a broad brush fund, like an MSCI emerging market tracker, which holds approximately 23 emerging markets countries, or hold specific countries within your portfolio."