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The world of investing can seem a bit daunting, particularly if you’re new to it.
Types of investment
What are your choices when looking to beat inflation and achieve your long-term objectives? Here we look at the main options available and highlight the potential benefits and pitfalls of each.
You can invest in almost anything, including the likes of fine wines and antiques. More traditionally however, there are four core areas of investment, or ‘asset classes’ as they are known.
Cash is the asset class with the least associated risk and is useful as part of a diversified portfolio as it offers security and easy access. There are many places you can hold cash, with banks and building societies offering cash savings accounts.
Whilst cash offers the benefit of easy access, it tends to provide lower long-term returns than other asset classes and its value can be eroded by inflation.
Bonds are issued by companies or governments looking to raise cash. By investing in a bond you
are in effect lending the issuer your money in return for a regular income and your capital back at a set date in the future. The characteristics of bonds mean they are a key portfolio component for more cautious minded investors.
Bonds tend to fluctuate in value less than shares and should repay your original investment at the end of a fixed term. However, the scope for your money to grow is usually limited in comparison to the growth achieved historically by shares, and there is the possibility that the issuer could default on the loan. Fluctuations in interest rates can also affect the value of a bond – generally when interest rates rise, bond prices fall and vice versa.
Although bonds are usually considered medium risk, this depends hugely on who is issuing them. Bonds issued by the UK Government are called Gilts and are very safe, whilst the risk involved in corporate bonds is dependent on the business issuing them. The level of income a bond pays reflects the risk you are taking – a company with a higher risk of default will have to reward investors with a higher yield.
Equities (or shares)
Equities are probably the best known of the asset classes and are quite simply an ownership stake in an individual company listed on a stock market index, such as the FTSE 100 in the UK, the S&P 500 in the US or the Nikkei 225 in Japan.
People invest in shares in anticipation of an increase in their value, and/or the receipt of a regular income through dividend payments. Whilst history should not be considered a guide to the future, it does show that over the longer term equities tend to outperform other types of investment.
Of course, shares can be volatile, and their value can go up as well as down and you may not get back the full amount invested and the fortunes between different shares can vary dramatically.
The scope of today’s investment world is greater than ever before, and whatever the angle, there is usually a collective investment fund providing access to it. Private equity, hedge funds and property are just some of the ‘alternative’ asset classes which are now easier for private investors to access.
The family home is the most significant investment many of us will ever make, and one that given time is likely to net a tidy profit. Returns from property investments tend not to be closely correlated with those of shares or bonds. This makes it useful from a diversification perspective introducing another source of capital growth potential and income into your investment portfolio.
Although property tends to be less volatile than equities and bonds, its value can fall as well as rise. It is also less liquid than other assets, meaning that it takes longer to invest into, and also to access your money when you need it.
Of course, focusing purely on residential property ignores other opportunities including those offered by commercial property. Property investment funds have proven popular as they provide access to commercial property to those unable to own for example an office block or a shopping centre.
Infrastructure funds invest in large, high cost projects, often connected to government and other public bodies development of core systems of transportation, communications, electrical supply etc.
Natural resources investment is investing in the companies (either directly or through funds) that are involved in the extraction of oil, gas, coal, metals and other natural resources.
Investing in individual companies carries more risk and requires more knowledge to make the right choices, to monitor your investments and make changes as necessary. For these reasons, adopting a collective approach can be extremely beneficial when entering the world of investing.
Mutual, pooled or collective funds are offered by investment management companies and provide easy access to a range of asset classes.
When you invest in a collective, your money is added to that of many other investors which professional fund managers then invest in a range of different assets e.g. equities, bonds, property etc.
Because your money is pooled with other investors, it means that even if you only have a small amount to invest, you can access a range of investments that otherwise you might not be able to.
Understanding your attitude to risk
When choosing how and where to invest, you need to establish a plan that reflects your investment goals, perspective on risk and the amount you are willing to invest. Establishing your attitude to risk is essential. How you feel about the prospect of placing money at risk and your ability to accommodate any potential loss in value is uniquely personal to you.
An investment which seems full of exciting potential to one individual can seem too risky to another.
Whether you are investing for the short, medium or long term is also important, and will have an impact on how you view risk. With a longer time horizon you may be happy to accept more risk for greater potential returns to achieve your objectives, however, the closer you get to your goal the less risk you are likely to want to be exposed to, and your investment approach will need to be reviewed and adjusted accordingly. Even the best laid plans can’t be expected to cope with all that life throws at you, and there are likely to be times when one-off events prompt a reappraisal and adjustments to your finances. There may be scenarios such as an inheritance, where you now suddenly have more wealth to manage than before or a divorce where a change in your circumstances will often necessitate a complete financial review. Either way, you will have to reassess your tolerance and willingness to take risk, particularly in the context of your long- term planning or retirement.
It’s not just future investment decisions that are likely to be affected, and you will probably find that any existing investments will need reviewing in terms of their suitability. Tweaking around the edges of your existing portfolio might not be sufficient and it makes sense, when things fundamentally change, to undertake a full financial health check – one that results in your finances being fully aligned to your new circumstances.
Diversification is key
Holding a range of different investments is one of the foundations for investment success. By not putting all your eggs in one basket you are limiting the impact of loss in any particular area and giving yourself the opportunity to generate investment performance from a range of different sources.
Get the balance right – getting the right blend between assets involves more than a random selection and requires a careful assessment of their respective characteristics, behaviours and interrelationships. Getting the balance right between different asset classes is key!
Some asset classes – like cash and bonds have more ‘defensive’ characteristics, whilst equities – which carry more risk – can offer greater growth potential for your portfolio. Ultimately, you should look to have ‘balance’, providing scope for out-performance, whatever the prevailing financial backdrop.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
Past performance is not a reliable indicator of future performance and should not be relied upon.