A successful investment process

If you set out to build something you will need a plan of action. If you start out without one you will probably find that the end result is not really what you wanted to achieve. It is no different with successful investing. You should follow a process and not just take pot luck or you might find that the end result is costly or at the very least disappointing.

Over time you can develop your own process but to begin with there are steps that you should not ignore when doing this for the first time as I will show you. 

The process to follow when investing has to be your own However, to be successful, there are stages that you should not ignore as I will show. You should not seek to choose any particular investment, type of investment, or investment fund in isolation – perhaps because it has won an award; had particularly good press; or achieved exceptional results. 

What might be a good fit for one investor might be totally inappropriate for another.  When deciding to make any form of investment, whether on your own or with the help of others, it is best to follow a process. 

I suggest that you initially go through the following steps and having done so you can then adapt it for your own situation in future.

Step (1) Can you afford to invest?

This may seem like a strange question but it is important to settle this at the outset.  You should pay off any short-term debt that you have before investing as the cost of your debt may well exceed the returns on your investment, net of charges and tax.  This is particularly true of credit card debt and store card debt where interest rates on outstanding balances can often be around 20% APR or above. 

It is also generally advisable to repay all or part of any outstanding mortgage where you can before investing a large lump sum.  There may be reasons why it is not appropriate to do this such as where you are locked into a fixed interest rate and early repayment would exact a penalty.  Even where you intend to invest monthly you might find that the alternative of overpaying your mortgage payments produces a more secure return over time.

Step (2) Do you have a sufficient emergency fund?

One of the salutary lessons taught by Covid-19 was the lack of financial reserves that so many families and businesses had, so that the sudden removal of income caused fairly immediate hardship.  Before considering any form of investment it is essential to have built up a sufficient emergency fund in easily accessible cash deposits. 

It is generally recommended that this should be a minimum of between three and six months’ regular expenditure.

Step (3) Have you allowed for any large planned expenditure?

Is there a real expectation that during the next five years you will purchase a property, get married, start a family, move house, start your own business etc.  If so, then you need to be building funds for this in cash deposits, cash ISAs, or near cash investments rather than investing for the longer term.  For any investment that has an element of equities (i.e. stocks and shares) or bonds (i.e. fixed interest investments) you should envisage a minimum investment term of five years, and preferably seven or more years, so these are unlikely to be of use to you for your shorter term planned expenditure. 

Of course, you should not put all of your long term investing or pension contributions on hold until you have enough money for such large planned expenditure.  The truth is that there will always be such expenditure on the horizon, both planned and unplanned.  A prudent process would allow you to invest for the medium and long term whilst continuing to build up funds for the planned shorter term expenditure.  If you simply do not have enough regular savings to do both then you really should look at your regular expenditure as you may be living above your means and it would be sensible to voluntarily cut back rather than have this forced on you through circumstances.

Step (4) What is the right amount to save or invest?

By the time you are age 30 you should be setting aside 15% of your net income towards pensions and long term investments. The aim would then be to increase this to 20% as soon as you are able thereafter.  This may seem a lot but if you think about it if you cease earning a salary or stop being self-employed at age 65 you then have to support yourself from your pension and investments for another 25 years or so.  So, assuming you work full-time for 40 years, each of those years has also got to support nearly eight months of your life post-employment. 

It has been said that a general rule of thumb is to have one times your income saved by age 30, two times your income saved by age 35, three times your income saved by age 40, and so on so that you have at least eight times income saved by age 65 and nine times income saved by age 70.  Depending on the standard of living you envisage in later life these should be taken as minimum goals.

Step (5) What is your attitude to risk?

This is a foundational question of any investment that you wish to make.  After all, if you are a defensive investor whose main priority is the security of your capital, then you probably will not want to stray much beyond keeping your money on deposit or in short term UK government securities (gilts). 

Every investment has an element of risk.  It is an unavoidable part of the investment process.  There are many different types of risk:

  • Inflation Risk – The risk that inflation will undermine the returns from your investment through a decline in purchasing power. Cash deposits and Bonds (i.e. fixed interest investments) are most at risk from inflation.

  • Investment Risk – The uncertainty of achieving the returns that you expect from an investment and the fact that you might get back less than you invested.

  • Volatility Risk – The risk that your investment value fluctuates over time and the growth you experience is variable.  Volatility is particularly noticeable in equity (i.e. stocks and shares) investments but is present to some measure in all investments apart from cash.

  • Diversification Risk – The risk that your investments are not sufficiently spread across different asset classes to ensure that the potential negative effects of exposure to any one variable are limited.

  • Product Risk – The risk that you lose out on potentially better returns through alternative options.  An example would be investing in a product which was less tax efficient for your circumstances than another product.

  • Target Risk – The risk that your investment does not perform as expected within the timeframe needed to achieve your objectives.  An example would be trying to build a specific pension fund for a particular retirement date or investing for school fees for a known school year.

Step (6) Establishing the level of investment risk that is most suitable for you

If you talk to a financial adviser they will use various tools to establish the level of risk that you should be taking with any proposed investment.  These will typically consist of, but not be limited to, the following:

  • Risk questionnaire – these are typically a series of questions from which you choose from a range of answers.  They are a form of psychometric test, the results of which show your attitude to investment risk.

  • Knowledge and experience questionnaire – this is seeking to ascertain your previous experience of investments, the risk to which you would have been familiar and whether you have had any particularly bad or good experiences of investing in the past.  It will also be looking to see if you have previously obtained advice before investing or whether you made your own investment decisions. 

  • Capacity for loss questionnaire – you may well have a fairly adventurous attitude to risk but if you are investing to achieve a certain minimum amount in five years’ time you cannot afford to be too adventurous as you may fail to achieve your goal.  In this case your low capacity for loss will dictate a more moderate risk investment.

  • Discussion – however good the tools are that have just been listed they cannot do the job on their own.  Once the questionnaires are completed you will need to have a detailed discussion with your adviser (or yourself!) covering your particular investment objectives and whether these will necessitate choosing a different level of investment risk.

Step (7) What do you want the investment to do?

You may say that is easy, I just want to make more money.  However this point should not be glossed over.  Will you require income from your investment and, if so, will that be from the outset or sometime in the future?  Do you simply require the prospect of long term growth in your investment or are you expecting to use some, or all, of the investment fund at a particular date? 

Are you investing for yourself or for someone else, such as a child or an elderly relative?  How important is capital preservation versus achieving a return in excess of inflation?  How important is the tax treatment of the investment?

Step (8) What assets do you want to hold?

It is advisable to spread your risk by investing across a range of different asset classes and geographical regions, rather than placing all your money in one type of investment.

The main asset classes are cash, bonds, equities and property.  These can be broken down into different markets, for example, how much in the UK, how much in the US and Europe and how much in Asia and the emerging markets?  There are also alternative asset classes, such as commodities, private equity and hedge funds that can also be considered, as these have become more readily available to retail investors. 

If this is not something you are comfortable deciding yourself then there are plenty of ready-made risk-rated, professionally managed portfolios run by financial advice firms and investment houses to suit the needs of most investors.

Step (9) What is your tax situation?

Tax awareness is essential when planning any investment.  You should be aware of both your own tax situation and the tax treatment of various types of investments.

  • Your tax situation – what is your marginal (i.e. the highest) rate of income tax – 0%, 20%, 40%, 45%?  If you are married or in a civil partnership what is your partner’s marginal rate of income tax?  Do you or your partner regularly make use of your annual capital gains tax exempt amount?  Are you and your partner making full use of your pension and ISA allowances?  Do you expect your tax situation to be very different when your investment is likely to be encashed?

  • Tax treatment of various types of investments – ISAs are free of tax; some investments such as pensions and venture capital trusts provide tax rebates; life assurance bonds can provide tax deferred ‘income’ and unit trusts and OEICs can make good use of your annual capital gains tax exempt amount or carried forward losses. 

Step (10) Do you have ethical concerns?

You may want to feel that your investments are doing more good than harm, or on the other hand you may have very specific requirements as to the type of companies that you definitely want to avoid in your investment portfolio.  If ethical concerns are a priority for you there are many ethical funds and investments from which you can choose or you can use portfolios of investments that are managed on an ethical basis for you. 

You should look for ESG funds. ESG stands for Environmental, Social, and Governance.

There is a wealth of information available to investors today who think that it is important to take an ethical stance, including fund fact sheets, fund research organisations and videos of fund managers talking about their investment process.

Step (11) What about the relative past performance of various funds?

It is important for you to be aware how particular investments or funds have performed in the past.  If a particular fund has produced abysmal relative performance for the last five years and there have been no changes to the management of the fund then it would be prudent to avoid investing in it.  On the other hand just because an investment or fund has produced stellar performance for the last five years is no indication that it will continue to do so. 

As we always have to say – past performance is not a guide to future performance.  In fact past performance may provide a completely wrong indication of what is to happen to the fund going forward. 

For example, the past performance may have been achieved by a particular fund manager who has now left; or by a few investments when the fund was small; or during a particular market cycle which has now ended.

Step (12) Will you use a financial adviser?

If you have worked your way through the process you are now ready to invest.  The final step is to decide whether you will be using a financial adviser.  Do you intend to research the various investments and investment funds to find those that meet your requirements or will you pass this responsibility over to a financial adviser?

Your financial adviser may be a professional person working for a company whose offices you can visit. This will typically be the case. If the amount you have to invest is modest and you are confident of using online services, you may wish to use one of the online ‘robo-advice’ services. 

You will have to pay for the services of a financial adviser.  On the other hand research carried out by Vanguard does identify the benefits of professional advice.  We quote from their research below.

In a recent study, we have been able to observe the effects of professional advice on a large number of clients with comparable experience. The data were mapped over a period of five years and we looked at the impact of advice from three perspectives, portfolio changes, financial outcomes and emotional wellbeing.  

The median age of the participants was 65, though ranges in separate areas of the study extended from under 30 to over 70. Median investible portfolios were between £190,000 and £390,000.  

Key findings  
Portfolio value: Over 44,000 participants were observed six months before and six months after obtaining professional advice. We saw that good advice can be particularly helpful in addressing private investors’ typical handicaps, such as procrastination, inertia, and home bias.  
Financial value: We looked at the likely financial outcomes for over 100,000 participants, finding that around 80% of the individual advised investors were highly likely to reach their retirement goals.  
Emotional value: In a survey of over 500 respondents, we found that the emotional, or personal, component of advice accounts for nearly half of the value assigned to the receipt of advice.  

Our aim in this study was not to define all of the possible measures for each of the three dimensions we observed, but to highlight the need to see advice from these different perspectives when assessing value.

On the portfolio metric, getting good advice helped address well-known issues affecting previously self-directed investors, such as home bias and inertia. In terms of financial outcomes, with the right advice, 80% of advised clients were put on track to meet their long-term financial goals for retirement.   But the third, emotional, dimension, while harder to measure, was just as important, or maybe more so – accounting for almost half (45%) of the value assigned to the advice relationship by investors. Without trust or the feeling of a personal relationship with their adviser, most investors are less likely to feel a sense of financial wellbeing.  

Good financial advice, it turns out, has more than the potential to underpin financial security. It can add to the quota of our happiness.

Written by Cynthia A. Pagliaro and Stephen P. Utkus.  


This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.

Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.

If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.