As we are constantly, and quite rightly, reminded, investment comes with an element of risk. Growth is not guaranteed: your investment may increase in value – but, it may decrease in value; you may make money – but, you may lose money.
The value of any investment is affected by economic, political and commercial factors that are outside any individual investor’s control – recognising this means accepting the risks associated with investment. But there are ways of mitigating these risks and, of these tried-and-tested methods, ‘not putting all your eggs into one basket’ is possibly the most important. If we’re going to invest our hard-earned money then we should try to spread it across a range of investment opportunities, creating a ‘diverse portfolio’ of investments.
Investment opportunities are generally referred to as ‘assets’, with those sharing similar financial characteristics being grouped together into ‘asset classes’. There are five generally accepted asset classes, these being:
- cash and money – bank accounts, cash ISAs and Premium Bonds
- fixed-income securities – corporate bonds and government bonds / gilts
- property – commercial funds
- equities – stocks and shares
In addition, there’s a variety of unique, standalone assets such as art, antiques, collectibles and cars. Within the classes, those items with physical form, such as property or commodities, are called ‘real assets’, whilst others, such as cash, equities and bonds, are termed ‘financial assets’.
- Cash and money
This class covers money held in current or savings accounts, cash ISAs and Premium Bonds and is investment in its simplest form. Putting your money in the bank, opening or topping up ISAs and buying Premium Bonds is easy to do, can be tax efficient and allows you instant access to your money should you need it.
‘Cash’ is generally considered to be the safest of all investment opportunities as it carries the least risk, so-much-so that in times of market volatility and uncertainty it’s often seen as being the investment option of choice. Although you’ll receive interest on your investment, its comparative safety is matched by low returns when compared to other classes; in fact, the value of your capital can fall if the interest rate you receive drops below the prevailing inflation rate.
Holding cash on deposit has little investment reward, its main benefit is that it’s easy to cash-in your investment should a better investment opportunity suddenly present itself or you need your money in a hurry.
- Fixed-income securities
This type of investment comes in the form of a ‘bond’ (not to be confused with an ‘investment bond’) which is, effectively, an IOU issued by an organisation borrowing money from a private investor and usually comes with a fixed return over a set period of time.
If the organisation issuing the bond is a company, it’s referred to as a ‘corporate bond’; if the bond is issued by the UK government it’s called a ‘government bond’, or ‘gilt’. Generally, the bond undertakes that the organisation will pay back the investment, along with the interest, by a specified date (the ‘maturity date’).
Corporate bonds and gilts are considered relatively low-risk investment opportunities: although it’s possible a company may default on its promise to either repay the capital or pay the interest due, it’s unlikely the government will. As there is an element of risk associated with them, both corporate and government bonds are rated by credit rating agencies, eg: Standard & Poor’s, Moody’s and Fitch, so that investors are aware of the level of risk they are being exposed to. A ‘prime’ bond with a rating of ‘AAA’ means the risk of default is extremely low – at the other end of the scale a bond rated ‘C’ or ‘D’ is in default.
Bonds offer a number of benefits to investors. They are generally lower-risk than equities, which means they can help reduce the overall level of risk in a portfolio; movement in their performance is usually opposite to equities (negative correlation: see later) which helps even out the peaks and troughs in a portfolio; the interest can provide a steady income stream; they’re transferable up until maturity and, should the issuing company fail and go into receivership, bondholders have priority over shareholders.
Property offers two distinct investment opportunities: residential and commercial.
Investing in residential property, either through home ownership or buy-to-let flats and houses, is a popular form of DIY investment. It’s easy to understand; it involves a tangible asset; we’re accustomed to thinking of owning a house as being a long-term investment and, apart from the occasional dip, slump and crash in the housing market, it’s generally accepted that the long-term trend in property values is positive. However, the downside is that buying multiple properties to create a property portfolio can be very expensive; a lot of capital is tied up in just one item; you generally have to provide some form of maintenance service to look after your asset and, if you need to get your capital back to ‘liquidate your investment’, selling the property can be a lengthy process.
The commercial property market works in a completely different way and, although you usually don’t have anything you can go and look at, it offers many advantages. The commercial property market can be accessed either by funds that are invested directly in commercial property or by investing in the shares of property companies so it’s far easier and less expensive to create a portfolio. Although it does suffer from periodic dips, it’s been shown that, together with fixed-income securities, movement doesn’t necessarily match that of the equities markets over the medium-to-long term; it provides a reliable income stream; no property maintenance costs are necessary and getting your money back is both quicker and easier as you are selling shares in a fund rather than bricks and mortar.
Property is considered a medium risk opportunity. ‘True investors’, those wanting to create a diverse portfolio of property investments, as opposed to those physically buying flat and houses, tend to use the commercial property market.
This is another word for stocks or shares. Investors can buy shares in limited companies quoted on the various stock exchanges around the world; buying the shares provides cash for the company and, in exchange for this, the company gives the investor a share in its ownership. If the company grows, the value of its shares rise representing growth for the investor; if the value of its shares fall, the investor makes a loss. In addition to the difference in share price, as a shareholder, the investor is entitled to a share of the company’s profits which take the form of periodic dividend payments and may also benefit from other financial rewards, for example, discounts on the company’s products or services.
New or less-mature companies may not be listed on the stock exchange – they have yet to be ‘floated’ – but it’s still possible to invest in them on a ‘private equity’ basis; ‘venture capital’ being a common method. Investors are attracted by the potential rewards of private equity and invest in the hope of generating an attractive return on their investment as the company grows. However, high rewards are usually matched by high levels of risk.
In the long-term, although equities tend to out-perform most other types of investment, risk levels can vary from fairly low to very high. Investing in a small or a new, start-up company may deliver good returns compared to a long-established heavyweight listed on the FTSE 100, but doing so comes at a much higher level of risk. If the company ceases to trade the investor risks losing their investment – shareholders are the last in line to receive payment after a company’s assets are sold off.
Although returns can be good, owning shares in a single company does have risks: it’s far better to invest in an equity fund as spreading your investment capital across the mixture of companies a fund represents reduces the risks associated with putting it all in just one basket.
This class covers a range of ‘alternative’ investments and was once called ‘commodities’, a term which, as the class has grown to include contemporary items, has now become a sub-class. An ‘alternative’ is any homogenous / standardised product that can be traded in bulk which means it has to satisfy three basic requirements: it must be in a standardised form, it must be usable and its price should be capable of variation.
Traditionally, commodities were a group of around 50 raw materials or primary agricultural products which were classified as being either a ‘hard commodity’, generally something that is mined, including gold, oil and natural gas, or a ‘soft commodity’, which are agricultural products such as coffee, sugar and wheat.
The ‘alternatives’ class has grown in recent years, the relatively small list of products expanding to embrace a disparate range of products that reflect the age within which we live. It now includes such things as foreign currencies, digital bandwidth and asset leasing along with ‘real assets’ such as social and renewable-energy infrastructure projects.
Alternatives are traded in a number of ways, either in the spot (or cash) market or in the futures market. In the spot market, buyers and sellers complete their transaction based on prevailing prices, the transaction usually resulting from the buyer needing the product or service being sold. The futures market offers the opportunity to buy and sell ‘obligations’ in advance, either ‘hedging’ or ‘speculating’ on future prices; it’s a fast-moving market with a language all of its own.
Alternatives are seen as a high-risk investment, partly because only one item is being bought and sold, and partly because the value is dependent on conditions within a specific market.
The five asset classes do not necessarily react in the same way when there are changes in the financial markets; some follow the market, other move in the opposite direction. ‘Positive correlation’ takes place amongst those classes which behave in the same way; ‘negative correlation’ takes place if they move in the opposite direction, a typical example being property and alternatives which tend to show negative correlation to equities and bonds.
Correlation is an effect that, yet again, illustrates the importance of having a diverse portfolio as gains in one class may offset losses in another, both mitigating your overall level of risk in the long term whilst increasing the growth potential of your portfolio.
How can One Financial Solutions help you?
“It’s not about timing the market, it’s time IN the market that counts.” is another of Warren Buffet’s legendary quotes. Apart from re-emphasising that investment should be treated as a long-term venture, it also underlines that ‘being in the market’ helps build the all-important store of knowledge and experience you need to be successful – something you can’t pick-up quickly.
One Financial Solutions is here to help you. Our advisers are experts who live and breathe investment – it’s how they make their living. They’ll take time to talk to you about your financial objectives, the level of risk you’re prepared to accept and any investment preferences you may have. They’ll provide expert guidance and, once you’re happy to go ahead, they’ll put everything in place and keep you updated for the duration of your investment.
So, if you’re looking for help with any aspect of investment, please call us on 020 3714 9565 or ask us to call you by sending an email to firstname.lastname@example.org.