Are you ready to invest?
Can you answer yes to the following;
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Am I free of debt?
No? then it's a good idea to pay off debts with high interest first, such as credit cards, before putting money away. This is because the interest you pay on those debts may be higher than the interest you could earn on your investment. -
Do I have enough money already set aside in savings accounts for emergencies?
Typically this should be 3-6 months salary. If not then you really should have this in place before thinking about investing. Take a look at the best savings accounts we have on the market first. -
Do I have enough insurance cover?
No? It's critical to cover unforeseen large emergencies such as illness, redundancy or death. If you're not covered already take a look at getting covered now.
If you were able to answer 'YES' to the above then you are in a strong position to consider investing. But once you're in a position to invest - there are a lot more thought-provoking questions to consider;
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Do I want to invest a lump sum or make regular monthly/annual payments into the investment?
You may have a lump sum to invest which you would like to see grow, or from which you wish to draw an income. Equally, you may decide to invest in instalments, say on a monthly basis, with a view to building up a lump sum. -
What am I investing for?
My retirement? Children's university fees? or just to build a lump sum? - Your goal will be a large factor in determining your investment plan so take the time to consider -
How long do I want to invest for?
Generally the longer it is before you need your money, the greater the amount of risk you are able to take in the expectation of greater reward. -
How much of a risk am I willing to take?
See our 'What Kind of a Risk Taker are you?' guide - Do I want an income from my investment?
- How much can I afford to invest?
- How would I cope if I lost the money that I had invested?
The foundation of investments
The underlying investment will typically be based on four different asset classes - shown below in order of supposed risk - lowest to highest:
Cash
When we talk of cash as an asset class we simply mean money that you invest in a bank or a building society that gives you interest as a return. We know it as savings really, but because it is seen as one of the four main asset classes -we need to mention it here. Investing in cash is the lowest risk and offers the undeniable benefit of security and also the advantage of ease of access to your investment. The downside is that the return on your investment is much lower than the potential income you may gain from one of the other asset classes. Cash deposited in a bank or building society is normally a great place to put your money if you are not needing a huge return on your investment and the money will be needed more for the short term (say under five years).
Advantages
- Capital security
- Interest
Disadvantages
- Inflation Risk
- Interest Rate Risk
- Bank / building society failure risk
Fixed rate bonds
Sometimes known as Fixed Interest Securities. A bond is a loan to a government (or a company) for a specific period of time. They will typically give a preset rate of return plus the repayment of your original investment, paying you a regular income from the interest until the loan is repaid. The income you earn when you hold a bond is known as the bond yield. Bonds will have a fixed term and generally give a higher interest than that paid on deposit accounts because they are deemed riskier than a deposit / savings account. The reason for this is that the price of bonds varies relative to interest rates and may therefore fall when interest rates are rising. Government bonds (such as UK gilts) are issued to raise funds typically for things like infrastructure investment. If the Bond is from a company then it is known as a 'corporate bond' - these tend to offer a slightly higher rate of interest because they are more risky than a government bond. Corporate bonds are issued to raise funds for activities such as expansion or R&D. You can invest in a spread of government and corporate bonds through a bond fund, investing this way lowers the risk. In general bonds are lower risk than shares/equities (see below) although this also depends on which specific bond you invest in. Do bear in mind that if the bond is not index-linked then you run the risk that inflation will erode the real value of your money.
Advantages
- Chance to earn more than you would in a savings account
- Steady income
Disadvantages
- Inflation Risk
- Interest Rate Risk
- Default and credit risk
- Currency risk
Property
When thinking in terms of an asset class for property we usually mean investing in a property fund for commercial property such as industrial and retail developments or city offices. Commerical and residential property markets are very different. Because commerical properties tend to be let out to companies for a long period of time (10 - 20 years) usually by the end of the time the value of the property has increased. Do note that sometimes pooled investments reserve the right to delay repayment to you (at the time of your selling) to allow them time to sell properties if needed. The delay is generally six months but can, on occasion, be longer. Your own property may of course be your biggest asset, but you cannot benefit from its value if you also need somewhere to live. The other alternative is to consider buy-to-let mortgages.
Advantages
- Steady income
- Long term capital growth
Disadvantages
- Liquidity risk
- Market price risk
- Interest rate risk
Shares
Owning shares in a company means you own part of it. In addition it means you can receive a share of the company's profit through dividends. Through the company's share price, you also have a share in the value of the company's assets. The hope is for the value of the share to increase over time as the value of the business grows. Shares tend to be the more volatile of the four main asset classes - their value can go up and down more than others. If you decide to invest in shares then you should be at ease with the fact that your shares may go down in value as well as up. To convert your shares back into cash, you have to sell them to someone else in the stockmarket. The price you get depends on a range of factors such as what other investors perceive the future profits of the company are likely to be.
Advantages
- Opportunity to earn high returns
- Protection against inflation - over the long term, share prices tend to beat inflation
Disadvantages
- Market Risk
- Currency Risk
- Company failure risk
Investment funds, unit trusts & OEICS
Unit trusts & OEICS
Unit Trusts & OEICS are a type of 'collective investment'. Collective Investments are often referred to as pooled investments. This is where your money is pooled with many other people's and it is then invested into one or more of the asset classes; cash, bonds, shares and/or property. There are a great variety of CIS (collective investment schemes) sold. A fund manager buys shares in a range of different companies and pools these in a fund; you then buy 'units' in the fund. Because the fund contains a range of shares the risk is spread. The price of units in unit trusts directly reflect the value of the underlying assets. So, if the fund invests in UK shares and the shares go up in value then you will see that the fund will go up in value at the same level. OEICS are similar to unit trusts in that the price directly reflects the value of the asset. It's simply the underlying structure that is different but otherwise they operate in the same way. Both pool your money with other peoples' to invest in a spread of shares or bonds, other investments or a combination of both.
Investment trusts
The main difference between investment trusts and unit trusts is that investment trusts are actually themselves companies with a fixed number of shares of it's own and which is traded on the stock exchange. So you are investing directly, rather than indirectly through an open-ended fund. The price of shares in investment trusts depends not only on the value of the actual investment but, in addition, because investment trusts are listed on the stock market - the popularity or in other words the market demand of it. What this means is that the actual price does not necessarily reflect the value that the investment holds. So sometimes you'll buy at a premium to the asset value and at other times you'll buy at a 'discount' or in other words pay less than the underlying value.
More information on Investment trusts... click here.
More advanced investing
CFDs - contracts for difference
Contracts for Difference (CFD) is a contract between buyer and seller to pay the difference between opening and closing value of share prices. They have the advantage of allowing people to make money on movements without actually buying the shares. CFDs are far more complex than some other form of investments (unit trusts, OEICS, investment trusts) and as such hold a higher level of risk to your money.
More information on CFDs... click here.
Financial spread betting
These days spread betting can be almost on anything you like - including sports & reality TV but originally, when the market started in the 1970s it was used as a way of speculating on the financial markets where the gain is by getting the accuracy of the gamble, rather than a simple "win or lose" outcome, such as the more typical fixed-odds betting. A spread is simply a range of outcomes, and the bet is whether the outcome will be over or under the spread. Spread betting has been a major growth market in the UK in recent years. Spread betting does carry a high level of risk, with potential losses or gains far in excess of the original money wagered.
More information on financial spread betting... click here.
Forex
Currency trading is about speculating on the value of one currency versus another. Major currency pairs are the US Dollar, the Euro, Japanese Yen, British Sterling and Swiss Franc. In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency. Before deciding to participate in the Forex Market, you should carefully consider your investment objectives, level of experience, and risk appetite. Most important - don't invest many you can't afford to lose.
More information on forex... click here.
What else is there to know?
As we said in the beginning, investments are a complex subject and shouldn't be entered in to lightly so before you sign on the dotted line do;
- Make sure you understand what you are signing up for
- Make sure you know all the charges and what impact they will have on your investment
- Make sure you check how your investments are performing - at the very least - once a year
- Go for safer investments the closer you get to retirement age
- Make sure you make the most of the tax breaks that are available
Want to read more on investments?
Types of investment | What kind of risk taker are you? | Contracts for difference | Share trading | Unit trusts explained | Online forex trading
Author: KYM Editor
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