What Are Investments?
Generally speaking, investments are something you buy or a place in which to ‘store’ your money, which in the long term, makes you a profit. There are four main types of investment, otherwise known as ‘asset classes’. These are:
- Shares – meaning you buy a stake in a company and when the value of said company increases, you sell the shares for a profit.
- Cash – savings such as money in the bank, ISAs or a building society account.
- Property – ownership of a physical building (or part of one). It can be commercial or residential.
- Fixed interest securities/bonds – you loan your money to a company or the government in return for a profit.
- You can also choose to invest in:
- Foreign currency
- Commodities (coffee, gold)
- Contracts for difference (you bet on shares which gain or lose value)
When you own assets you are said to have a portfolio. Owning varied types of asset will see a better performing portfolio as the risk is generally lower because if one investment fails, you still have others to fall back on. This is known as ‘diversifying’.
When your investments start to make money you are said to be seeing returns from your investments. The money could be returned to you in several ways depending on where you invested it. You could get:
- Dividends if you invested in shares
- Rent from properties
- Interest if you made cash deposits or fixed interest securities
- Capital gains / losses made on business transactions.
More About Diversification
Asset allocation not only spreads the risk, it can help increase your returns whilst maintaining, or even lowering, the level of risk in your portfolio. Just say you had a portfolio made up 100% of premium bonds. This might be fairly low risk but would most likely provide you with far lower returns than a portfolio of 100% equities, though be aware that the behaviour of individual asset classes can change. Adding 10% in equities to your portfolio will increase the risk but also increase the potential returns as one generally moves up when the other moves down (negative correlation).
There is no such thing as an absolutely ‘no-risk’ investment. You are always dealing with some degree of risk when you invest but the risk varies between each type of investment. For example, Money placed in secure deposits such as ISAs and other savings accounts risk losing value in buying power over time as the interest rate you receive won’t keep up with rising inflation forever. Other, index-linked investments that follow the rate of inflation don’t necessarily follow market interest rates meaning that a dip in inflation earn a disappointing return.
Stock market investments sometimes beat inflation over time, but there is a risk that the prices won’t be as high as you imagined when you want to sell meaning a poor return or a possible loss.
Understanding that you are going to encounter risks when investing and deciding how much risk you are willing to take is fundamental. Even with a long time frame, and a substantial amount of cash to fall back on, a high-risk approach probably isn’t for you if this would cause you anxiety.
Be realistic about how much you can afford to invest. Remember your liabilities, such as debts, insurance premiums, pension contributions, and living costs, and assess how much spare cash you have to invest. Investing works best with a long term view.
What Should I Invest In And How?
To diversify most effectively you should begin with the four main asset classes: cash, bonds, equities and property. Furthermore, you should aim to sub-diversify within these asset classes. So for example this could mean investing in properties in different regions and for different purposes (rental/investment), or in a combination of corporate bonds/government bonds. You can also reduce risk by including other types of asset that at first appear fairly random like gold or oil, or in hedge funds.
In order to choose the right asset allocation you should decide how much time you have to invest, how much you expect/need to earn from your investment, how much risk you are happy to take and how much you can realistically afford to realistically lose if the markets fall.
You can buy shares directly through a stockbroker who is registered with the Financial Conduct Authority. Alternatively, You can invest in equity funds using a fund supermarket.
Countries that are thought to be the most economically developed are considered to have ‘developed markets’. They are said to be less risky than others but this does not mean that investing in them completely risk free. Furthermore, it is important to note that some companies listed in developed markets may do business primarily in that country. It’s possible that most of their business is in emerging markets, but they choose to list on one of the world’s leading stock exchanges. You need to become familiar with a company’s background before investing. The following are considered to be developed:
- UK – funds invest in companies listed in the UK. Some invest for growth. Others will look to produce some growth and income by investing in companies that pay high dividends for example.
- North America – funds invest in companies listed in North America.
- Europe – funds invest in companies listed in Europe. Some include the UK, others don’t.
- Japan – funds invest in companies listed in Japan.
Shares / Equity Funds
The traditional way to invest is to buy shares in companies. As a shareholder, you have an equity stake in a business, which is why shares are also known as equities. Investing this way means you buy shares in one or more companies with the aim of making a profit. There are different ways to do it but the principle of investment remains the same: you gamble with your money and there is no guarantee you will get it all back. The price of shares is set by the firm selling them depending on the firm’s financial position on any given day.
The best way to invest this way is to choose a small number of shares or funds, monitor them closely and cash them in when needed. In general, it is about maintaining a level headed approach to the stock market and generate good returns that can overcome downturns and surges. In the UK, people buy and sell billions of pounds worth of shares every single day on the London Stock Exchange. There are roughly 3,100 different types of companies to buy shares in. Shares are listed on an ‘index’ and the UK’s biggest is the FTSE 100 – being the 100 biggest firms.
Investing In Property
Property can also be a good way to invest your money, though it is not completely foolproof. Remember the financial crisis in 2007? Many property investors lost out, however, the property market is still an important asset class to consider as a way of spreading, or diversifying, risk in your investment portfolio.
For private investors, direct investment in property means literally a whole property, or a share in one. This is not the most practical way of getting a foot in the door of the commercial property market.
Alternatively, referred to as bricks-and-mortar funds, a more common way to invest is in commercial property, via a collective investment scheme like a unit trust, Oeic or investment trust. These invest directly into a portfolio of commercial properties which can include supermarkets, offices and warehouses, which you could not do alone.
Indirect property funds are collective investment schemes. They invest in the shares of property companies listed on the stock market. They do not have the benefits of diversification like direct investments in property, because property shares can move up and down with stock markets.
Of course there is the buy-to-let route to invest your funds but you need to be fully aware of all of the costs you may encounter when you become a landlord.
Cash As An Asset
Cash is an important part of any investment portfolio. It is the only asset class that doesn’t pose capital risk. You won’t lose any actual money by placing your money in ‘cash’.
Cash can protect your money. If you’re uncomfortable with risk, you can keep much of your portfolio in cash and then diversify later if you wish, into other asset classes. Consider the risk-reward trade-off however, as the more you have in cash, the lower returns you are likely to receive. This is not to say though that there aren’t any risks whatsoever with cash. You could find the spending power of your money fall if inflation is higher than the interest rate you receive a phenomenon known as inflation risk.
The different ways to invest are
- Money Market Funds – Collective investment schemes which offer different financial products.
- Cash ISAs – In the 2019-20 tax year, you can place up to £20,000 into a cash Isa and can top up your Isa account annually. Any profit is tax-free. Remember though that if you want to move your Isa to a higher-interest product, transfer it rather than taking out the money and re-investing or there may be tax related implications.
- Savings Accounts – be sure to look at all the features they offer as they vary a great deal.
- National Savings & Investments (NS&I) – a government-backed savings and investments service which offers a range of products to help you save money and are fully protected.
Investing in gilts, government bonds and corporate bonds means placing money with different bodies such as companies or governments, which pay you a regular income from the interest for a set period of time, after which you get your investment back.
The most common forms of fixed-interest investment are:
- Gilts and index-linked gilts
- Other government bonds
- Corporate bonds
- Permanent interest-bearing shares (Pibs) and perpetual subordinated bonds (PSBs).
Gilts are fixed-interest securities from the UK Government, offered when it wants to raise money. They are generally considered to be very low-risk investments. Index-linked gilts pay interest linked to the Retail Prices Index (RPI); their value rises with inflation.
Government bonds are also issued by governments.
Corporate bonds are issued by companies who need to raise capital. They are riskier than gilts, as companies are generally considered to be more likely to go bankrupt than stable governments though this is reflected in the offer a higher rate of interest rate.
Permanent interest-bearing shares (Pibs) are like corporate bonds but are usually issued by building societies.
Remember if you have various investments you should protect both in life and after death. Writing a will can ensure your estate is managed in accordance with your desires in the future. It will help protect your family at this time and ensure all your hard work has not been in vain.