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When it comes to investing you have a bewildering variety of choices as to what you can invest into. Unless you are already familiar with investments you have only three different types of
investment; Cash, Bonds, and Shares. Each of these investment types have different characteristics, and you need to blend them into your investment plan.
Cash is simple to understand. Cash on deposit earns some interest, maybe. As with all investments you should consider the rate of inflation carefully.
Call Deposit If you hold cash where it is available on demand the rate of interest these days will be minuscule.
Term Deposit If you have more than say £5,000 you might consider placing cash on deposit for a period of say 3 months or say a year. Interest paid should be higher and at the end of the set time you get your money back with interest.
Peer To Peer Lending Not strictly cash but I suggest it belongs here. This is a fairly new concept where a company acting as a go-between enables you to lend very small amounts of money (say £20) to people or small businesses. In this way you get a higher return of say 7-8% whilst keeping default risk low. For personal lending look at Zopa and for business lending Funding Circle. Not easy to get your money out instantly.
Bonds come a a variety of forms and are easy to understand. Consider them as a long term cash deposit. They are issued by a borrower such as a government, corporate entity, or indeed other
types of entity. The quality of the issuers can vary greatly, even if they are backed by a government. They usually carry a fixed rate of interest and pay out interest once or twice a year.
You can buy and sell them, and their price will change according to changing interest rate expectations. They are issued for usually 5 to 10 years, sometimes much longer. On maturity if the
issuer is solvent you get repaid at the face value of the bond, £1 for £1 nominal face value.
Gilt This is a bond issued by the British government, considered to be above reproach.
Corporate Bond A bond issued by a company, quality varies giving you choice.
Index Linked A bond issued by a government or company which has its value and iiterest return linked to inflation. They usually have a very low yield, which is improved by reference to say the Retail Price Inflation Index.
Floating Rate Note A bond where the income is linked to a reference and which should rise or fall in accordance with prevailing interest rates. The capital value does not usually vary.
Foreign Bonds You may be able to buy these directly, or more likely buy a selection of bonds in a particular currency through an ETF (Exchange Traded Fund). These have added risk in the form of foreign currency movements.
Others There are other types of bond. Unless you know what they are they are probably best avoided.
You should consider the following when investing:
- Who is the issuer and will they default?
- What is going to happen to interest rates?
- What should be the average life of my holdings?
- Should I have any index linked issues?
Of particular note is the maturity of bonds. Bonds normally mature at their face value, usually £1. Until they mature their value will fluctuate according to prevailing interest rates. If interest rates fall bond values will rise. If interest rates rise bond values will fall. The closer to maturity the less they fluctuate. As a rough guide the number of years a bond has to mature will be approximately the change in price for every 1% change in prevailing interest rates. So a bond with another 10 years to run will move roughly 10% for every 1% move in prevailing interest rates. Be very careful about investing into bonds with more than 10 years to maturity.
A useful link:
Shares are what people normally think about when investing. Many shares are for a single company, whilst other shares and funds are a way to invest into bundles of shares which may be invested into a share indices, a market, or indeed specialised sectors. Shares are among the most volatile investments and can see very substantial moves up an down. Consider the extreme volatility in most stock markets over the last 15 years. Getting into markets at the right time is key, as is getting out in a timely manner. There is no easy way to do this, although a look at share indices can provide some guidance.
These are some share buying choices:
Single company share Normally you would have a spread of different companies to reduce volatility in a portfolio
Investment Trust A UK listed company which invests into other companies. They can be in a variety of sectors or oriented for say income. Usually very low costs.
Exchange Traded Fund (ETF) A listed fund which can be invested into shares which mimic the performance of a share index, different markets, or market sectors. Usually very low cost.
Unit Trust and Similar These are invested in many areas. Beware of high costs in terms of a buy/sell spread and of hidden annual management fees.
It is particularly important when constructing a portfolio to think what you are trying to achieve and invest appropriately. Read widely and use your judgment. Shares are very volatile but can provide the best returns, so they should not be overlooked. Ring fence your long term portfolio from any punt-of-the-month shares, as you want to keep long term investments managed correctly.