Investments
Why are we encouraged to save money?
From childhood, most of us are told to put away money to save for the future – perhaps for something special; or maybe to be sure that when we really need something we have the funds to acquire it, without taking on debt. People’s aims are broadly the same; to provide for future needs, and to protect ourselves against unexpected expenditure, events and inflation.
When planning your finances, it is important to distinguish between savings and investments. Savings are generally funds that you set aside that can be accessed relatively quickly. These savings are often for a specific need or purchase, like a holiday or a new car. The most common way of saving is into a bank account (‘deposit’ account) where the money can be accessed in an emergency, and for every £1 you put in, you will get £1 back and possibly some interest. In other words, the original capital is guaranteed.
Investments are designed to be held for a longer term, usually at least 5 years. You need to be comfortable with tying up this money for a period of time and should not consider investments unless you have some savings in place. Most investments are not guaranteed to return your money in full, although do offer the prospect of potentially higher returns than deposit accounts. Returns, risk and volatility are the factors that will determine a suitable place for your investments.
The value of investments may fall as well as rise. You may get back less than you originally invested.
Investing and Risk
Whether you are looking at investing in a pension, an investment bond or ISA (Individual Savings Account), you might consider using investment funds. A fund is capital belonging to numerous investors, held in one place and used to collectively purchase securities, while each investor retains ownership and control of his own shares. Buying large numbers of shares or achieving a portfolio of investments may well be beyond most average investors so they effectively club together to increase their purchasing power.
Typically, these pools of money are run and managed by an investment specialist. The manager is paid to make the day-to-day decisions of where the pooled money is invested. The fund manager uses their expertise to make suitable investment decisions in order for the value of the pooled fund to hopefully grow over time.
Another advantage of pooled investment is being able to diversify.
Investment Options
Current accounts may offer a very low rate of interest (if any) but they are the most flexible in terms of accessing your money. Banks also offer savings accounts with higher interest rates and notice accounts with competitive interest rates, but you may have to give a certain amount of notice before making a withdrawal (60 or 90 days perhaps), or you must agree to invest the money for a set period.
These are generally considered low risk as they are government backed. Many of National Savings products are tax-free.
These are generally considered to be lower risk than direct equities, although the value can still fall as well as rise. Corporate bonds are investments based on business loans offered by private companies and are ‘rated’ based on the ability of the issuer to maintain interest payments and repay the loan. A corporate bond fund will invest in a wide range of these loans. ‘Investment grade’ stock within the bond fund is rated AAA to BBB, whilst stock rated a BB or below is termed ‘junk or non-investment grade’. Some funds also invest in government bonds (known as gilts).
The income yield that is available from fixed income investments varies according to the quality of stock. Lower quality (junk or non-investment grade) stock usually offers a higher yield to attract investors (as they may be otherwise put off by the increased risk/volatility) whilst gilts generally offer much lower returns, they are underwritten by the government and so the risk of default is much reduced.
The long-term historic performance of commercial property has very little correlation with the performance of corporate bond or equity-based investments. For investors looking to diversify their portfolio, property funds have historically offered attractive returns. Income from commercial property funds is often derived from contractually binding contracts of rent paid by business tenants to occupy property. Consequently, leases are often arranged over a long period and generally include an ‘upwards only clause’ which ensures that rents are not negotiated downwards during the lease period, even in times of falling markets.
Added to the rental incomes, property has the added attraction of potentially appreciating in value over time, and although property values do fall, the ‘bricks and mortar’ assets of a fund remain. However, returns from a property fund are not guaranteed and the value of any investment can fall as well as rise.
Furthermore, because of the nature of property as an asset, it may not always be possible to immediately switch or cash in your investment, because the property in the fund may not always be readily saleable. If this is the case, then a fund manager may defer your request to cash in for a period of time. You should bear in mind that the valuation of property is a matter of the valuer’s opinion, rather than a matter of fact.
All these types of investment are available through your financial adviser. You may be able to include your investment within a tax-efficient product such as an ISA (Individual Savings Account) or a pension. There is a vast array of products available, and choosing the most suitable one can be difficult, your adviser will be able to help you decide which are suitable for you.
The value of investments may fall as well as rise. You may get back less than you originally invested.