New to Investing

What are investments?

Investments are something you buy or put your money into to get a profitable return.

Types of investments

Most people choose from four main types of investment, known as ‘asset classes’:

• Cash: the savings you put in a bank or building society account, and which pays you some interest.

• Shares: you buy a stake in a company, and you hope the value of your shares in the company rise. Depending on the company, you may also be paid a dividend. (Shares are also known as equities and stocks.)

• Fixed income securities (also called bonds and Gilts): you loan your money to a company or to the government and they will pay you regular interest payments and hopefully return your original capital at the end of the term.

• Property: you invest in a physical building, whether commercial or residential

There is a fifth category which includes hedge funds, derivatives, cryptocurrency, high yield “junk” bonds: high risk equities and art and collectibles. This category may have a place for wealthy investors or a for a very small allocation by the less well-off but are less likely to be seen in an average investor’s portfolio.

Investment in shares, fixed income and property may be arranged directly by the investor making their own selections or via professionally managed funds.

The various assets owned by an investor are called a portfolio.

As a general rule, spreading your money between the different types of asset classes helps lower the risk of your overall portfolio under-performing.

Investing can bring you many benefits, such as helping to give you more financial independence and, in the long run, a comfortable retirement. As savings held in cash will tend to lose value because inflation reduces their buying power over time, investing can help to protect the value of your money as the cost of living rises.

Debt and emergency cash fund

Before you begin to invest it is sensible to pay off debts, especially short term borrowing. The interest rate you pay on the vast majority of short-term debt is likely to be many times higher than the rate of return on any investment you make.

Consider building up an emergency cash fund before you begin to invest. Many experts recommend having an emergency fund that can cover your outgoings for between 3 and 6 months.

Contribute to your pension or tax efficient savings accounts

Many people of working age will benefit from a workplace pension, a way of saving for your retirement that’s arranged by employers. For all but the highest earners, you don’t pay tax on money invested in your workplace pension, meaning that your money will go further. These benefits make pensions ideal for investing longer term as they are generally tax efficient.

However, if you’re not enrolled in a workplace scheme, it’s important to think about how you will fund your retirement. If you are paying directly into a private pension scheme, then it’s important to maintain regular monthly contributions. So be sure to contribute to your pension on a regular monthly basis before you make any other investments. Depending on your circumstances your financial adviser may suggest a Lifetime Individual Savings Account or LISA instead of or in addition to a pension. LISA’s may hold cash and qualifying stocks and shares investments including funds – see below.

So, if you have paid off short term debt, you have got your emergency cash and you have made suitable pension contributions and you hope to see your money grow over the long term, then you could consider investing some of it.

The right savings or investments for you will depend on how happy you are taking risks (your risk tolerance) and on your current finances and future goals. If you are struggling with any of these decisions, consider taking professional financial advice.

Returns are the profit or income you earn from your investments; if your investment loses money it is known as a negative return.

With an instant access cash account, you can withdraw money whenever you want, and it is generally considered a secure investment. The same money put into fixed income securities, shares or property is likely to go up and down in value but should grow more over the longer term, although each is likely to grow or shrink in value by different amounts during the boom to bust investment cycles we experience!

Depending on where you put your money, returns could be paid in a number of different ways:

• Dividends (from shares)

• Rent (from properties)

• Interest (from cash deposits and fixed income securities).

• The difference between the price you pay and the price you sell for – capital gains (capital growth) or losses.

None of us likes to gamble with our savings but the truth is there is no such thing as a ‘no-risk’ investment.

You are always taking on some risk when you invest, but the amount varies between different types of investment. The more risk you take the greater the chance of bigger profits and bigger losses.

• If you place money in secure deposits such as savings accounts, you are risking losing value in real terms (buying power) over time. The problem is that the interest rate paid seldom keeps up with rising prices (inflation). On the other hand, index-linked investments that follow the rate of inflation do not always follow market interest rates. This means that if inflation falls you could earn less in interest than you expected. There is a small risk that your deposit-taker will fail but as a UK investor you have some protection under the Financial Services Compensation Scheme.

• Stock market investments might beat inflation and interest rates over time, but you run the risk that prices might be low (for example if the economy is in recession) at the time you need to sell. Generally, stock market investments should be viewed as longer term investments with at least a five-year time horizon.

This could result in a poor return or, if prices are lower when you sell than when you bought, losing money.

When you are completely new to investing, it is usually a good idea to spread your risk by putting your money into a number of different products and asset classes.

That way, if one investment does not work out as you hope, you have still got your others to fall back on.

This is called ‘diversification’.

One of the most important aspects of risk is the extent to which the value of your investments is likely to swing up and down.

This is called capital risk, and the swings up and down are called volatility. Different asset classes have different levels of risk.

For example, cash (saving in things like savings accounts) has low capital risk.

Ranked in order of increasing capital risk, the traditional asset classes generally come out like this:

• Cash

• Fixed income

• Property

• Shares

If you want a low-risk portfolio, you should aim to hold a high proportion of your investments as cash and fixed income securities but your chances of protecting against inflation are low.

A higher risk portfolio will have a relatively high proportion in shares.

Be careful though because risk is often just seen as a negative; remember though, if you do not take risk, you are unlikely to make capital gains.

Timing investments is hard at the best of times, but during volatile or depressed markets it can be even tougher. If you are confident, you can make lump sum investments.

The alternative is Pound Cost Averaging (regular saving) which is a simple strategy that can be used by investors who are worried about timing their investment in challenging markets. It is the manner in which most pension contributions are invested over one’s working life. Investors who can accurately time the tops and bottoms of markets (either through luck or through skill and judgement) will not benefit from this approach. However, by staggering investment, some of the effect of rising and falling markets over the period of your purchases can be smoothed out by buying some shares at lower prices if the market falls, but ensuring you are at least partially invested at the lower levels if the market rises.

Investors will be aware of the warning that past performance is not a guide to future performance but it is clear that equities have overpowered inflation over most time periods.