Is a volatile stock market still the best alternative to risible savings rates?

Investing in shares is not without risk, but if you do your research and can commit to a long-term strategy you could prosper. Esther Shaw reports

Like many people who want to make their savings work for them, Louise Dungate has become increasingly frustrated by low interest rates. Undaunted by the prospect of taking a risk, the knitwear designer from Balham in south-west London decided to dip her toe in the stock market in an attempt to get a better return.

Despite the unsettled financial climate, the decision has proved profitable for the 29-year-old following her first investment 18 months ago. “Prior to that I’d had money in cash Isas,” she says. “As I’m self-employed I don’t have a regular salary, and need to make my money work as hard as it can.”

Dungate made her first investment in a self-invested personal pension (Sipp). More recently, she opened a stocks-and-shares Isa. “My Sipp now includes investments with Unilever and Lloyds. In the past 18 months I’ve seen the value of my portfolio rise by 4.74%,” she says.

Turning to the stock market could be a more attractive proposition for savers at present, with rates on cash at rock bottom. Ongoing low inflation, weaker economic data, global uncertainties and the weakness in the oil price mean there is little pressure on the Bank of England to raise interest rates any time soon.

Already, tens of millions of people have exposure to the market through their pension pot or Isa, but it’s been a turbulent start to the year. “It’s the worst start on record, in fact,” says Jason Hollands from adviser Tilney Bestinvest. “Markets have reacted to poor economic data from China. The FTSE 100 has been hit hard.”

But while the FTSE may have plunged, one of the upsides of lower share prices is that dividend yields have leapt up on many of these shares.

“The current yield on shares has increased significantly over the past nine months, with the yield of the FTSE 100 index now at a very attractive 4.25% per year,” says Patrick Connolly from adviser Chase de Vere. “The yields on some well-known individual shares look even more enticing, with HSBC at 7.6%, BP at 8.3%, Shell at 9% and Glencore at 14.4%.”

When you invest in shares, income is distributed in the form of dividends. These payments are usually made half-yearly as a reward for holding the company’s shares. As a shareholder you can either take the cash or use the money to buy more shares in the company. Reinvesting dividends can dramatically boost returns over the long term – provided the shares go up.

With yields looking good – Shell, for example, has committed to paying a dividend for the next three years – savers may be wondering about investing their money. The problem is, while the possibility of high yields is appealing, this doesn’t tell the full story.

“Income yields show the level of dividends paid as a proportion of the share price,” says Connolly. “The reason why many shares have attractive-looking yields is because their share prices have fallen, rather than because companies have been increasing their dividend payouts. It isn’t a good position for an existing investor to have a high yield on their shares if this is the result of them having already suffered a big capital loss.”

Many companies, and particularly in sectors such as oil and commodities, he says, are under pressure. “It would be no surprise to see some companies cutting the level of dividends they pay. This could, in turn, lead to further falls in their share price.”

Damien Fahy from finance website MoneytotheMasses, says: “Would-be investors shouldn’t just focus on the current yield of a share. They also need to focus on the likelihood that the dividend will be maintained – and indeed increased – year on year. Shell may have committed to paying a dividend for three years, but elsewhere there has been a swathe of companies cutting dividend payments.”

For Dungate the hope to getting a higher return on her money is worth the risk. “I appreciate that investing in the stock market is risky, but I’m willing to take this risk in the hope of getting a higher return. I’m not investing everything I have, and am prepared for the ups and downs.”

Should you take the risk?

While rising stock market yields may make shares more attractive than other asset classes – such as fixed interest, property and cash – you need to be aware of the risks involved.

“Unlike a cash savings account, investing in the stock market risks losing money,” says Justin Modray from finance site Candid Money. “It’s all very well enjoying a healthy dividend payout, but this may be little consolation if stock market falls mean you’ve lost 10% of your original investment.”

If you are simply fed up with the low rates on cash savings but would endure sleepless nights worrying about the prospect of losing money, the stock market is not for you. “It is better to put up with poor cash returns and sleep peacefully knowing your money is safe,” Modray says.

This is a view shared by Danny Cox from adviser Hargreaves Lansdown: “While the yields may currently be attractive, those uncomfortable with capital risk should stay in cash.”

Invest for the long term

That said, if you are happy with the idea of taking on some risk this could be the time to take the plunge.

“Right now the average variable rate cash Isa is yielding just 0.85%,” Cox says. “This makes the yields on stock markets look very attractive. Equally, investors who brace themselves for the ups and downs will look back at this as being a decent entry point. The UK markets are reasonable value, and a long way off their all-time highs – so provide long-term profit opportunity.”

The key is to only invest money that you can afford to leave there for at least five or 10 years – to smooth out any bumps in the market.

“The volatility of the markets may be off-putting for first-time investors, but the increased investment risk does mean that over the long term there is the potential you could achieve greater than you would from a savings account,” says Fahy. “According to the Barclays Equity Gilt Study equities have produced an average return of around 5.5% a year over the past 50 years. However, in that time there have been big market falls as well as rallies.”

HOW TO GET STARTED

If you are investing in the stock market for the first time, you need to tread carefully. Decide what you want to achieve, how long you are planning to invest for, and how much risk you are prepared to take. Does your homework or take advice – visit unbiased.co.uk, a website that helps you search for local financial advisers?

■ Investment funds investing in individual shares after researching a company carries a high risk. Reduce this by investing in a range of shares through investment funds.

■ Equity income funds for those looking to invest in companies with healthy dividends. Equity income funds typically invest in a spread of FTSE 100 companies. Top picks from Tilney Bestinvest’s Jason Hollands include Standard Life UK Equity Income Unconstrained, Ardevora UK Income, and the smaller company-biased Unicorn UK Income fund.

■ Shop via a platform Good for first-time investors, DIY investment platforms resemble an online supermarket from which you can select from a range of investments provided by different companies, but which are purchased and held in one place. These allow you to mix and match funds from a range of managers, plus you can access a wealth of research, information, tips and tools. Remember to look at the service offered as well as any administration charges, dealing fees and any other extra costs. Platforms include Hargreaves Lansdown, Bestinvest, and The Share Centre.

■ Costs Obviously these vary, and the cheapest option will depend on the types of investment you want, and how big your portfolio is. If you invest in funds expect to pay between 1% and 2% in charges. If you want someone else to run a portfolio of trackers for you – and do the asset allocation – Nutmeg is an option. With annual fees of between 0.3% and 1% it may be a good option for novice investors.

■ Use your Isa If you’ve not used your Isa allowance it is worth popping your funds or shares inside this tax-efficient wrapper.

■ Drip-feed your money Reduce the risk of market timing by investing regular premiums on a monthly basis rather than putting in a lump sum. That way if the market falls you simply buys at a cheaper price the following month. You may be able to invest from as little as £25 a month.

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