The following article is a guest post from our friends at Nutmeg, the UK’s largest digital wealth manager. Money Dashboard users get 9 months fee free investing when they open a Nutmeg account. More info here. Capital at risk.
One of the most difficult decisions when investing is ‘what should I invest in?’. The golden rule is: ‘don’t invest in anything you don’t understand’.
You can invest in almost anything, from coffee beans to gold, but the four fundamentals are: shares, bonds, property and cash. In this section we explain a little more about each one.
Shares are quite literally a share in the ownership of a company. If you buy a share in a company, you own a portion of that company.
Depending on the class of share, that can mean you are able to vote at the annual general meeting on decisions such as the salary of the chief executive officer. It also means you get a share (or portion) of the profit of the company. This is the dividend.
Shares are a valuable part of a portfolio because, alongside the dividend income, the price of a share can rise over time as well. So, you could sell your share for more than you bought it for, therefore making a profit.
Of course, share prices rise and fall all the time. That is why owning individual shares can be very risky. A portfolio with a number of different shares diversifies your risk. It is possible to buy a ready-made portfolio that represents the whole stock market, or a section of it. These are called trackers.
The price of shares in larger companies are quoted on the stock exchange. In the UK the main stock exchange is called the FTSE, (more fully, the Financial Times Stock Exchange.) And there are two main indices – the FTSE100, which is comprised of the 100 biggest companies listed on the stock exchange, and the FTSE250, comprised of the next 250 biggest companies.
Bonds are a loan to a company or a government for a set amount of interest over a set amount of time. Government bonds are usually seen as very safe investment asset because you are essentially lending the government money, and it is very unlikely the government would default on the loan. For governments, bonds are the main way they can raise funds without increasing taxes. The UK treasury issues bonds which are known as gilts (because in the past the paper bonds were gilt-edged).
You can also get a bond from a company seeking to raise money. For example, Tesco might issue a bond for 10 years at 4%. This means that the buyer of £10,000’s worth of this bond lends Tesco £10,000 which Tesco keeps for ten years. During the ten years, Tesco will pay the investor 4% per year, or £400, and at the end of the 10 years, the £10,000 will be returned to the investor. Totally, they will now have back £14,000 from the initial £10,000 – a return of £4,000 plus their initial investment.
The creditworthiness of the company is important as a company that is seen as more risky (with a lower credit rating) will have to offer a higher interest rate to attract lenders.
During the 10 years, the bond can be bought and sold. The price will depend on how the interest rate compares with interest rates more widely. For example, if interest rates are low, the bond will be relatively attractive and the price will be higher than the £10,000 initially paid. If the credit rating of the issuer changes, the price of the bond might also change.
As a class, bonds are usually less risky than shares. This is because interest rates do not change on a day-to-day basis, although a shift in interest rates will affect all bonds. Like shares, individual bonds are generally riskier than a portfolio of bonds, and it is possible to buy a bond fund representing a large collection of individual bonds.
Read more about bonds, what they are and how they work on the Nutmegonomics blog.
There are two types of property for investment: residential, which is accessed by buy-to-let, and commercial, which is most often accessed by property funds. For both, the income stream is from rent, and it is hoped that the capital value of the property will increase as well.
Property is an illiquid asset. It can take months, or even years, to find a buyer for a property and then several more months to complete on the property sale.
With a residential property investment (buy-to-let), you have to consider your deposit and any equity you accumulate as locked in until you sell. Another big risk is related to interest rates. If you have a mortgage and the interest rate goes up, it might be some time before you are able to increase your rental income to cover the mortgage costs. You also need to remember the extra costs of buying and maintaining a property, such as stamp duty, solicitors’ fees and insurance.
Read more in our paper: Should you invest in property or stocks and shares?
Cash is very secure in that it is not subject to investment risk and it is very liquid — you can take it out of the bank and/or transfer it into other assets (spend it) at any point.
The amount of money in your bank account will not change in response to external events (unless you get hit by negative interest rates) but its value will be affected by inflation.
The two risks of investing in cash are inflation and bank failure.
While very unusual, banks have failed in the past, most recently during the great financial crash of 2008. Your cash is usually protected by the financial services compensation scheme up to a maximum of £85,000 in each bank, although you might have to wait a short time to get hold of your money.
5. Alternative Assets
You can theoretically invest in anything – from wine to bitcoin. However, a lot of these ‘alternative assets’ exist in unregulated markets. For example, there are no rules or regulations governing how cryptocurrency is traded, or how it is valued. Likewise, the provenance of an asset such as a painting can be disputed, meaning it can be hard to value or sell.
For these reasons, those seeking alternative assets will usually see them as passion projects, rather than the mainstay of their investment portfolio. Putting money into an investment portfolio holding equities, bonds and some cash is more likely to provide returns with much lower risk than investing in alternative assets.
6. Socially responsible investing
Finally, it is worth considering other metrics in your investment. Socially responsible investing (SRI) allows you to choose shares, bonds and other assets that are only issued by companies and organisations that adhere to standards promoting good environmental, social and governance values. By choosing SRI, your investments could avoid companies that profit from war, or which have bad human rights or polluting records. Instead, you could invest in companies seeking to change the world for the better.
SRI is a valid investment option when it comes to the bottom line. We have seen evidence that SRI portfolios are providing higher returns than non-SRI portfolios and are being increasingly sought out by investors wanting their money to do good and work hard. An apt way to see SRI is ‘investing for the world you want to retire in’.
You can read more about SRI and how and why it is so timely in Nutmeg’s SRI whitepaper.
How do I know what to invest in?
Just as it is recommended to invest in a number of shares rather than just one share, it is advisable to invest in a collection of asset types rather than a single type. For example, it is riskier to invest everything in the FTSE100, rather than having some gilts and bonds as well.
So which type of assets do you pick and how much of each?
This depends on your appetite for taking on risk. A slow and steady approach will typically have more bonds and gilts, while a more growth focused strategy will tend to have mostly shares from a range of countries but may have some other assets as well.
You can start today:
Once you’re ready, you can start investing with Nutmeg today. It’s simple, straightforward and we’ll be on hand to help you answer questions you might have.
Nutmeg is offering a special offer of no portfolio management fees for 9 months for Money Dashboard users. To take advantage of this offer, start by entering your email address on our partner page. You’ll then be able to see the sorts of returns associated with each type of Nutmeg investment, with a sample portfolio.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not an indicator of future results and future returns are not guaranteed. Tax treatments apply.