In a low-interest rate environment, it is always tempting to take on more risk in the hope of getting a better return.
This may explain why the Alternative Investment Market (AIM) has seen a steady surge of investments ever since mid-June 2016, when the Bank of England lowered the base rate to a historic low of 0.25 per cent.
The AIM offers access to a range of potential growth stories – from the small start-ups which may or may not be the next Apple, to well-established private companies which have recently gone public. It is also a great place to find investments in up-and-coming sectors such as robotics and biotech.
If you don’t want to put all your money into just one or two individual companies, there are dozens of AIM-specific Exchange Traded Funds (ETFs) which can spread your exposure across the entire AIM index.
So, what’s the catch?
The AIM is made up of small-cap companies which don’t qualify for the FTSE All Share Index, where the UK’s largest 600 or so companies are traded. Any company can apply to be listed on the AIM, and there is no minimum size or turnover requirements.
However, to be considered for an AIM listing, companies must pass a rigorous regulation assessment which can take up to a year.
The sheer cost of this process means that eligible companies tend to have an existing source of funding available, or a reasonably high turnover which can cover this expense.
Once listed on the AIM, these firms can take advantage of their new public funding to accelerate their growth.
The likes of Domino’s Pizza, and the Booker Group both began on the AIM before graduating to the FTSE 250, netting investors a big windfall in the process.
However, not every company on the AIM is solvent and thriving. Small cap stocks are notoriously unpredictable, and high-profile bankruptcies are not uncommon.
Just two years ago, £2bn iron ore company African Minerals went into insolvency, leaving investors out of pocket and driving down the overall value of the market.
And according to research by the London Business School, between 1995 (when the market was launched) and 2015, 72 per cent of the companies to have listed on the AIM have lost their shareholders’ money.
The same study also found that shareholders lost 95 per cent or more of their initial investment on almost one in three AIM-listed companies.
While the potential for big returns is certainly high, the odds are stacked against most AIM investors.
As a result, AIM allocations tend to make up only a small proportion of most investor portfolios, and these are usually managed by experts in the sector.
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How to Invest in the AIM
If you intend to invest in the AIM, there are three golden rules that you need to follow:
Spread your risk
When AIM companies fail, investors can lose everything. This is an untenable risk that should be avoided at all costs.
Instead of choosing one or two firms to invest in, spread your money across a range of stocks in different sectors, or invest via an ETF, which will diversify your portfolio automatically.
Wrap your investment in an ISA
Most AIM investments (both direct and indirect) qualify for inclusion in a Stocks and Shares ISA.
Use your ISA allowance to avoid paying unnecessary tax on your returns, and benefit from compound interest over time.
Review your portfolio regularly
The AIM is prone to volatility as certain companies take off and others fall into insolvency.
Any significant market movements should act as a reminder to review your portfolio and switch up any allocations which no longer match with your risk profile.
You can never know too much about the stocks in which you are investing, so keep tracking the market and amending your investment portfolio as often as possible.
By following these three rules, you should be able to avoid any significant losses, and pick at least a few high-yield stocks along the way.
AIM investments can be hugely profitable – and enormous fun – just as long as you’re prepared to put in the work.