This can be classified as money you might need to have available at short notice, or money you are setting aside for a specific event that you know will come up in the not too distant future, e.g. a holiday or a wedding. Normally savings are kept with a bank or building society.
Money that you can afford to set aside for a longer period of time, for example for over five years. However, you should bear in mind that investments are not always guaranteed to return your money in full.
Insurance helps to protect you against risks. Investment-type life insurance pays out a lump sum on maturity or alternatively a reduced amount if surrendered earlier. This is known as the surrender value. Whole-of-life insurance is different to investment-type life insurance in that it only pays out in the event of death and is not an investment vehicle – it is a protection vehicle. Investment-type policies, normally tend to cost a lot more than protection-only insurance.
There are different types of investment-type policies:
What is a with-profits policy? With-profits policies are long-term investments provided by insurance companies. They might be called endowments, investment bonds or with-profits bonds. With-profits policies usually include some life insurance cover. People often invest in these:
With-profits products are based on funds that invest in a mix of shares, bonds, cash deposits and property. Policyholders' share the return from these investments and in a number of cases the profits and losses of the insurance company. The with-profits fund also meets the claims of policyholders (death benefits for example), the costs of running the business and maintaining the reserve fund. It may also have to meet the cost of paying dividends to shareholders of the insurance company.
What is a unit-linked policy or bond? Unit-linked policies are normally single premium, lump sum products often called bonds that usually have a minimum single investment of between £2000 and £5000. Your lump sum buys units in a fund and the value of those units increases over time with investment income (from dividends or interest) and through the increase in value of the fund's investments. As with other pooled investments there is, of course, no guarantee that the value of your investment will increase. A single premium unit-linked life assurance is really a policy designed to be held for five years or more. If you decide to cash in (surrender) before the end of the period that the policy is due to run for, there could be heavy penalties. Charges can be complex, and can include an initial charge through a bid/offer spread of 5% to 6% in the price of units, a unit allocation charge and an annual administration or management charge of around 1% to 1.5%.
Some unit-linked policies are also structured as endowments. These are similar to with-profit endowments in that monthly premiums are paid over the duration of the policy. The nature of the product is different, however in that the return is not dependent or linked to the profits of the insurance company, and any bonuses added. In the same way as a single-premium unit-linked bond, this product buys units in a fund and the value of your investment will grow and vary in line with the value of the fund's investments.
What is an income and growth bond? An income and growth bond is a type of single premium investment. Generally, the investment is linked to the performance of a stock market or some other factor such as a collection or "basket" of shares. They are usually held for a fixed number of years and provide income, growth or a combination of both. In some cases the original capital invested may be protected, however, most income and growth bonds are structured capital-at-risk products (SCARPs) also known as precipice bonds. The customer is exposed to a range of outcomes in relation to the return of their initial capital sum. In addition, the amount of initial capital repaid may be 'geared ' e.g. consumers may lose 2% of their capital for every 1% fall in the market past a certain level – this is the 'precipice' element. If the index, indices or basket of shares perform within certain thresholds, full repayment of the capital invested occurs (in addition to the income or growth on the capital). However, if the performance is outside these thresholds consumers could lose a substantial part, or even all, of the capital they invested.
When shopping around for life insurance policies it is important to compare products and prices from a range of providers. The following are general points to consider when 'shopping around';
Very often life assurance policies are used for the purposes of financing property purchases. There are different ways of financing a property purchase, with the two main methods being via the use of an endowment mortgage or a repayment mortgage. Additional guidance in relation to these is provided on a separate page - Property Purchases.
A share is simply a part-ownership of a company. If, for example, a company has issued a million shares, and you own 10,000 shares in it, then you own 1% of the company. As a part-owner of a company, you are investing in the management of the company. You should invest in companies you feel confident are well run.
At its most basic, the stock exchange is a market which brings together people who want to buy shares in a company, and those who want to sell their shares. The laws of supply and demand determine the prices buyers and sellers settle on. The companies whose shares can be bought and sold on the stock exchange are referred to as listed companies.
Capital Growth: Over the long term, shares can produce significant capital gains through increases in share prices.
Some companies can also issue bonus shares to their shareholders by way of a "bonus issue" as another way of passing on company profits or increases in their net worth. A bonus issue occurs when money from a company's reserves is converted into issued capital, which is then distributed to shareholders in place of a cash dividend. A bonus issue does not change the value of your investment.
Many listed companies also make what are called "rights issue" where they provide opportunities to their existing shareholders to buy more shares in the company at a discounted rate and without the need to buy through investment services firms, thereby saving on fees. Companies do this as a way of raising more capital for expansion, and it provides you with an opportunity to increase your holding in the company at a discounted price if you are confident of its potential.
Dividends: Companies may pay a portion of their profits to their shareholders in the form of dividends. The amount of dividends to be paid to existing shareholders is usually determined and approved at the company's Annual General Meeting. The amount of profit which is not distributed is ploughed back into the company in the form of reserves. Such accumulation of reserves is then used by the company for future projects.
Buying and Selling: Compared to other investments (such as property), shares can be bought or sold relatively quickly through an investment services firm. You can, if you so wish, sell part of your holdings in any shares. Diversifying: As part of your investment strategy, you may have part of your money invested in shares. You may buy shares directly on the stock exchange, units in a collective investment scheme that invests in shares or via an insurance policy that invests in shares.
As with all other investments, prices of shares can go up as well as down. Sometimes, share prices can change substantially as a result of reaction to some news which may affect the listed company. Whenever there is news about a listed company which shows, for example, improvement in its profits, investors tend to react positively by purchasing more shares into the company. As the demand for the shares increases, so will the price because people will be less willing to sell their holdings in the shares. This is referred to as the law of supply and demand - when demand increases, prices increase. On the other hand, prices will start to fall sharply when investors, react negatively to news about the company, and will dispose of their holdings as quickly as possible to minimise any dramatic downfall in the value of their shares.
There are instances where share prices can fall dramatically. Do not get into a panic - think carefully before selling your shares quickly at a loss. In fact, do not buy or sell on the basis of a change in price only. Your decision to buy or sell should also be based on an analysis of the company's annual report, changes in management, news about the company etc.
A company is not obliged to pay periodic dividends, even if it has made profits. Hence, you may find that although in one year a company has paid out dividends to its shareholders, the following year that same company may choose, for a number of reasons, not to share part of its profits with its shareholders. Therefore, shares are not suitable if you want a periodic (such as annual) payment of interest. Shares are perhaps more suitable for those seeking capital growth and are prepared to take some risk.
Are all your eggs in one basket? Ask yourself: is this your only investment or your biggest investment (except for your home)? If all your money is going into purchasing shares only or in units of collective investment schemes which invest in shares, you will be taking a bigger risk than someone who has invested in a variety of other safer products.
You should rely on the professional advice of your investment services firm and your own research when deciding which companies to invest in. The following points provide you with some suggestions regarding sources of information available to the investing public.
An Initial Public Offering (sometimes referred to as IPO or "flotation") occurs when a company offers its shares to the public for the first time to raise capital. For this purpose, the company issues a prospectus, which is a document that will help you decide whether the company is a suitable investment for you. A prospectus is required by law to contain all the information you and your investment services firm would need so as to make an informed investment decision about the company. It must clearly disclose any risks associated with the investment.
You should not only be interested in what the prospectus says but also think about the matters that it is silent on. Understand the assumptions in the forecasts - many companies make profit forecasts in their prospectuses which are not met. You need to read the prospectus critically and decide whether the assumptions made in the prospectus are reasonable. The company should disclose what assumptions have been made in preparing those forecasts.
One of the best ways to protect your share investments is to be an involved shareholder in the company. You should be interested in what happens in the company and exercise your powers as a voting shareholder. Keep an eye on your investment because circumstances may change and the market value of your investments will certainly change.
Material sent to you by the company: You will usually receive regular information from the company. Listed companies are obliged to publish an annual report which is distributed free to all shareholders. Read whatever material is sent to you by the company. If the information is late, check with the company.
Receipts and paperwork: Always request receipts from your investment services firm and keep all the paperwork about your investments in a safe place.
A bond is a debt security. When you purchase a bond, you are lending money to a government or a private corporation or another entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond, sometimes referred to as the principal, when it "matures", or comes due.
There are various types of bonds you can choose from: local and foreign government securities e.g. government debentures or national savings bonds, corporate bonds, developing country bonds and eurobonds. There are some types of life-assurance based policies that are also called bonds. These types of bonds are not however the same.
Most investment services firms recommend that investors maintain a diversified investment portfolio consisting of a range of securities in varying percentages, depending upon individual circumstances and objectives. Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and to increase their capital or to receive dependable interest income.
There are a number of key variables to look for when investing in bonds: the bond's maturity, redemption features, credit quality, interest rate, price, yield to maturity and tax status. Together, these factors help determine the value of your bond investment and the degree to which it matches your investment objectives.
- Short-term bonds - maturities of up to four years;
- Medium-term bonds - maturities of five to 12 years;
- Long-term bonds - maturities of 12 or more years. Some bonds do not, however, have a maturity date.
You may have heard your investment services firm mention the term "triple A" or simply an "A". These are called "ratings". Each international bond is usually given a rating by a rating agency. These agencies - such as Moody's or Standard and Poor's - give these ratings when bonds are issued and monitor developments during the bond's lifetime. Such agencies maintain research staff that monitor the ability and willingness of the various companies, governments and other issuers to make their interest and principal payments when due. Your investment services firm can supply you with current research on the issuer and on the characteristics of the specific bond you are considering. Each of the agencies assigns its ratings based on an in-depth analysis of the issuer's financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond. The highest ratings are AAA (Standard & Poor's) and Aaa (Moody's). Bonds rated in the BBB or Baa category or higher are considered investment-grade; securities with ratings in the BB or Ba category and below are considered below investment-grade.
It is extremely important to understand that, for any single bond, the high interest rate that generally accompanies a lower rating is a signal or warning of higher risk.
Market Fluctuations - The link between Price and Yield: From the time a bond is originally issued until the day it matures, its price in the marketplace will fluctuate according to changes in market conditions or credit quality. The constant fluctuation in price is true of individual bonds - and true of the entire bond market - with every change in the level of interest rates typically having an immediate effect on the prices of bonds.
When prevailing interest rates rise, prices of outstanding bonds fall to bring the yield of older bonds into line with higher-interest new issues. When prevailing interest rates fall, prices of outstanding bonds rise, until the yield of older bonds is low enough to match the lower interest rate on new issues. Because of these fluctuations, you should be aware that the value of a bond will likely be higher or lower than both its original face value and the purchase price if you sell it before it matures.
Assessing Risk: Virtually all investments have some degree of risk. When investing in bonds, it is important to remember that an investment's return is linked to its risk. The higher the return, the higher the risk. Conversely, relatively safe investments offer relatively lower returns.
These are financial products where money from a number of different investors are pooled and then invested by a fund manager according to specific criteria. The scheme or fund, as they are more generally known, is divided into segments called 'units', which are to some degree similar to shares. Investors take a stake in the fund by buying these units - they will therefore become unit holders. The price of a unit is based on the value of the underlying assets the fund has invested in. Collective investment schemes may have different fee structures - make sure you understand how you will be charged before you invest as charges may have a major impact on the performance of your investment.
Collective investment schemes can invest in shares, bonds, bank deposits and other financial products. Usually, fund managers select the investments they think will do best and switch from one to another as market conditions change. However, fund managers are obliged to follow prescribed investment criteria which are set out in the fund's prospectus.
There are a wide variety of types of funds:
You can earn money from your investment in a collective investment scheme in three ways;
Usually funds will give you a choice: it can send you payments for distributions and dividends ("Distributor" funds), or you can have them reinvested in the fund to buy more units (called "Accumulator" funds).
Read the fund's prospectus and shareholder reports, and consider the following:
Read the sections of the prospectus that discuss the risks, investment objectives, and investment policies of any fund that you are considering. Funds of the same type can have significantly different risks, objectives and policies.
You can get a clearer picture of a fund's investment objectives and policies by reading its annual reports. If you are not receiving these reports, you should contact your investment services firm or the fund manager of the collective investment scheme for a copy.
You can also research funds at most reliable internet sites and investor journals or newspapers.
One final hint - generally the success of your investments over time will depend largely on how much money you have invested in each of the major asset classes - shares, bonds and cash - rather than on the particular securities you hold. When choosing a collective investment scheme, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.
Risks and potential returns vary greatly from investment to investment. Shares offer you growth, but they can be volatile. Bonds provide you with income although they come in varying risks. Collective investment schemes can provide you with growth, income or both but are also subject to volatility in the value of the underlying investments and lower potential earnings.
Strategic investing involves allocating your funds in a variety of ways - diversifying among different plans. Once you have evaluated your investment goals, assessed how much money you can reasonably invest, determined your risk comfort level, and learned about your investment choices, you are ready to build a diverse portfolio of investments.
A portfolio is the collection of all your investments: all the shares, bonds, cash deposits, property, and so forth. Careful investing involves building a diverse portfolio, one in which your investments are spread over a range of investment choices.
Because there is no certainty as to how your money will grow over time, diversifying investments can help protect you when some investments do not perform as well as others. Investing in collective investment schemes allows you to diversify within a class of investments such as shares or bonds without actively designating where the money should go among these individual investments.
Once you make a lump sum investment in a collective investment scheme, a fund manager takes care of spreading that sum among a range of investment options. In exchange for their services, collective investment schemes generally charge you a fee, based on the amount of your yearly assets in the fund.
Individual investors, especially those with long-term investing plans who are willing to absorb market shocks, may feel confident investing a portion of their money in shares. Within the world of shares, there are many ways to diversify as well.
For example, you can invest in blue chip shares - large, established companies with strong records of profit growth that also often pay dividends whilst growth shares - often companies that are just starting out - provide another option. Growth companies, whose earnings are increasing at a rate faster than the industry average, are often smaller companies today, but may not be for long. You can also diversify your investments in shares by purchasing shares in a variety of industries. Owning securities in a variety of industries offers some protection - when one industry is declining, another may be growing.
After examining the various ways to invest money, you have to decide what percent of your income you want to invest where. Like the other components of an investment plan, your need for a diverse portfolio may change over time.
As you determine your investment strategy, here are some points to keep in mind:
A Contract for Difference (CFD) is a type of "derivative". The term derivative is very common and is used to describe any product that is based on an underlying instrument. Instead of buying a share and holding it, the CFD investor comes to a deal with a CFD provider that at the end of the contract, one side or the other will pay the difference between the opening price of the contract and the closing price. The investor can therefore trade in individual equities without the need to become a registered shareholder or take physical delivery.
When an investor starts a contract, the investor might only have to put up a small part of the contract value which may be between 10 and 20 per cent depending on the volatility of the share. This is known as a margin. However, the nature of the investment means that the investor's losses could eventually exceed the margin money - therefore brokers often insist that you deposit a minimum of £10,000 before trading.
The sale or purchase of a financial instrument at the current (spot) price for settlement and delivery at an agreed future date. Unlike futures, forward contracts are not normally traded on an exchange.
Contracts that are made for the delivery of, for example, currencies or commodities on a future date. Future markets provide an opportunity for speculation, in that contracts may be bought and sold (with no intention of the traders to take delivery of the goods) before the delivery date arrives, and their prices may rise and fall during that time. Futures contracts are normally traded on an exchange.
An option gives the holder the right but not the obligation to exercise the purchase or sale of certain securities. An investor may pay a premium in return for the option to buy (a call option) or sell (a put option) a certain number of securities at an agreed price (known as the exercise price), on or before a particular date. The dealer may exercise his or her option at any time within the specified period and normally does so at an advantageous time depending on market prices. Otherwise the dealer may allow the option to lapse.
Bets on moves in house price, bonds, currencies, shares etc. In spread betting you never actually own the share, commodity, or the bond that is the subject of the bet. Your bet is on the spread, not the underlying instrument. In this way a spreadbet is sometimes construed as more of a gamble than an investment. Spread betting carries a high level of risk to your capital. Prices can move against you and can result in substantial losses that may oblige you to make further payments. Unlike conventional betting, in spread betting you can lose more than your initial stake. Because of the volatility in the markets, spread betting is an investment mostly associated with experienced or professional investors who have an in-depth knowledge of the markets.
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