It’s pointless to keep money lying in your bank accounts. If your savings goal is far away into the future, you can start investing your pounds. This allows you to earn from your investments and keep up with rising prices in the economy. Investing is a minefield so you should have a thorough understanding of the potential benefits and hidden hazards. Keep reading for the explanation of various associated topics. We cover:
- What are investments?
- What are returns?
- How do fees reduce returns on your investments?
- What are risks?
- Which are the high-risk investment products?
- When should you start investing?
What are Investments?
Investments are financial products that you buy or put money into. The aim of investing is to earn a profitable return on your money. By simply buying financial products of such a nature, you can grow your money quick and easy. There are four main groups of investment, also known as ‘asset classes’. These are:
- Shares- buying a stake in a public or private company
- Cash- savings you deposit into bank or building accounts
- Property- immovable land or building, for residential or commercial use
- Fixed interest securities (bonds)- issued by companies and government
Some investors might also opt for other lesser-known investment products like:
- Foreign currency
- Collectibles- art and antiques
- Commodities- oil, coffee, corn, rubber or gold
- Contracts for difference- betting on whether shares will gain or lose value
The assets that a person owns are grouped together into a portfolio. It’s a sound idea to invest in different asset classes to lower the risk of an under-performing portfolio. For example, if shares of a particular company go down while your land increases in value, you’ll be the gainer.
What are Returns?
Returns are the earnings you get from your investments. Investing, if done after careful consideration, can give out high returns on your pounds. Basically, it’s the profit you earn from financial products. They’re all a source of income from your assets even though they are understood and taxable under different heads. Here is a list of most common returns of UK citizens:
- Dividends- payable on shares
- Rent- from properties on lease
- Interest- from cash deposits and bonds
- Capital gains and losses- calculated as a difference between the purchase and sale price
How do Fees Reduce Returns on your Investments?
If you have the time and knowledge needed to manage your investments effectively, well and good. Most people prefer to seek advice and entrust their investments in the hands of a financial advisor. This however isn’t free and the advisor will charge you for their service. These fees eat into your returns and you should check before you invest. On the basis of the financial product you’re investing in, investment management charges, administration charges and platform fees might apply.
What are Risks?
Nobody wants to gamble with their savings but the fact is that investing has its risks. There’s no investment product on the market that is potentially “no-risk”. Some degree of risk, either less or more, always comes when you invest. Let’s look at the risks some products possess.
- Savings accounts– When you keep money in savings accounts of banks and building societies, they pay you interest on it. Although these are secure deposits, you risk losing value in real terms after some years. Inflation deflates buying power to a large extent. It buys fewer things for the same amount of money which is a loss of buying power. Interest rates don’t always move upwards with rising inflation.
- Index-linked investments– Index-linked investments follow the inflation rate in the economy but are less likely to follow market interest rates. That means your earnings would also fall with a fall in inflation.
- Stock market investments– In stock market investments, the sale value is what determines whether you’ll be a gainer or not. They beat inflation and interest rates but you might have to sell it for a low price if you’re in need of money. You could lose money if you bought it for more than you sold.
The best way to protect yourself from the risks of investment is through diversification. The idea behind it is to invest in different asset classes rather than one. This would help you spread the risk and offset losses if one asset didn’t perform as you hoped.
Which are the High-Risk Investment Products?
High-risk investment products give big payouts, at the same time are also considered big risks. Some high-risk investments we discuss here are…
- Structured products:
A structured product is a type of investment in which your returns depend upon a set of rules. It makes no difference whether shares in it lose or gain value. Some of these are designed to give a regular income, others have capital growth on offer and some offer both. E.g. guaranteed equity bonds, guaranteed capital plans, protected investment funds, guaranteed stock market bonds.
- Venture Capital Trusts (VCTs):
There are some companies that provide funds to new and upcoming businesses to set up and grow. They are Venture Capital Trusts (VCTs) and have special tax advantages. A professional fund manager runs the show and picks out companies that have a high success potential. However, individual perceptions and judgement can and do go wrong. Therefore, you may lose more than you invest. You can think about it if you don’t have issues locking your money in for at least a five-year period.
- Spread betting:
Spread betting is actually making a bet on the happening of an event. For example, placing a bet on share prices going up or down. These days, you can place bets on almost anything like reality TV, sports and politics. It’s a riskier undertaking so make sure you read and understand the terms and conditions before placing a spread bet.
- Contracts For Difference (CFDs):
A Contract for Difference is much the same as spread betting, only here you bet on an asset’s value rising or falling. The ‘contract’ is an agreement that exists between you and a broker. You agree to exchange the difference between the cost of an asset at the beginning of the contract and end of the contract. For instance, if you predict that an asset will increase in value and it decreases, you’ll end up paying the broker the difference.
When Should You Start Investing?
This is a decision every individual has to take for himself or herself. Generally speaking, the right savings for you will depend on how happy you’re with the level of risk, your current finances and future goals. If you have enough money in your cash savings account to last you for the next six months, you should consider investing some of it.