Hello everyone! Today’s post is for people new to investment who aren’t quite sure of what investment products might be right for them. It’s a confusing world out there, so today we’re trying to explain what each potential investment product does and how it might fit into tolerance for risk.
The Financial Wilderness is a big fan of investment when it’s done carefully and safely and believes that it pays off longer term – you can read a more detailed post on exactly why that’s the case here.
As ever – our normal note that we take care with what we write on this site but it is not official “financial advice” and whatever investments and savings you enter need to be right for your circumstances. We always suggest doing your own further research. If you’re in doubt about anything, it’s worth consulting a regulated and reputable financial advisor who can provide tailored advice built for you.
So let’s get started – what investment products exist for our investment pile?
Investment Product Types
Firstly just a quick note that these are generally structured in order of the risk of volatility, with the least volatile investment products first.
Savings-Type Investment Products:
These are types of returns based around bank accounts, which some people would not think of an investment product. However, they’re still somewhere we place our money expecting a return – in my book that makes it a very low risk investment.
Current Account:
Well you should be pretty familiar with this one so I won’t say too much about it! You’ll earn a little interest from a bank account at practically no risk, with your savings up to £85,000 protected by the Financial Services Compensation Scheme. You’ll receive a small rate of interest for your deposit.
At the time of writing, interest rates aren’t unfortunately pretty terrible and you’re doing well to get 0.5% back on any money you have in the bank.
The advantage of a current account is safety and convenience – however in times when inflation is increasing (which means the gener price of things is going up) the “real world” value of what you have in your account may be falling as the interest being paid doesn’t keep up with price growth.
(NB: Many new arrivals in the UK such as international students struggle with opening a new UK Bank account without a UK address history – if this is you then check out MeMoreMoney’s guide to options for opening a bank account in the UK without proof of address.)
Term Account:
Banks don’t literally put your money in “the bank” when you make a deposit – they’re wanting it so the money you’ve given them as a saver they can lend out to others who want to borrow and get a return on it.
It’s therefore helpful to them to the bank to know that you intend to leave your money with them for a set period so they can plan around this – and reward you for it.
A term account therefore pays a higher rate of interest in exchange for you locking your money up for a set period – it’s a little bit more for you for a little bit of inconvenience.
Term accounts can be a helpful tool as if you hit a point of dire need, you can usually withdraw your money and simply forego the interest you would have earned. (Check the terms of any term accounts before you do this, as some don’t let you withdraw at all.
You’re simply trading off a time commitment of where your money sits for a slightly greater reward.
You can read the Wilderness’s advice on picking out the best possible UK bank accounts here.
Traditional Investment Products
From hear on out we are discussing more traditional investment products in the form of bonds or equities. These provide a greater return but also expose you to greater risk of loss – precisely how great that risk is depends on the specific bond or equity, as it’ll be unique to who you invest in.
This article explains the products, and if you’re thinking of how you should balance Fixed Income/Bonds in a portfolio we’ve got an article for that!
Bonds or Fixed Income:
A bond is where you buy the debt of a company or institution (such as a Government) – essentially it’s you lending someone some money and getting an “IOU” for the same amount plus a little more back.
I’m grossly oversimplifying here but the primary risk to you is usually credit risk (the risk that the person will not pay back the money you have lent them via the bond.
Lending to the UK Government is pretty much guaranteed – you know what they’re about and you know you’re likely to get your money back. Lending to DodgyCompany of DodgyCountry – well you might feel a little less certain.
This is reflected in the bonds rates of return as the more risk exists that you might not get the money bank, the more compensation they have to pay to you to make the bond an attractive investment.
The amount a bond pays out should therefore relate to the level of risk involved – if a bond is paying you a really high rate, you should ask yourself why – excess returns (such as anything about 5%) should send alarm bells ringing rather than happiness about the rate of return.
In terms of timeframe you’ll commit to a period of lending the money, usually between 3 months to 5 years, and expect higher returns for locking your money away for longer periods. This obviously may mean you cannot use it for other opportunities.
In terms of payouts, bonds may either repay the initial amount (which may be referred to as the principal) plus your interest at the end of the period or pay you occasional smaller amounts during the period of the investment (known as coupons) before returning your original investment at the end.
If you’re a novice investor, you are likely to be able to find simple fixed-rate bonds issued via your bank/building society, or to invest in via an index fund (more on that below).
Investing in an individual company’s bond in the wider market is a more risky proposition and should be treated with great care by the inexperienced investor and preferably under advice.
Higher end names can be a good investment, but those with low-quality credit profiles (known as junk) have a high probability of loss via the underlying company going bust and not paying out.
Equity:
So in the case of bonds you’re buying the debts of a company. In the case of equity (also known as stocks or shares) you’re buying a piece of that company, essentially a small ownership stake. The value of it will therefore change alongside the value of the company.
Equities in general are this far down the risk-list because they are much more volatile than bonds, with larger swings in markets seen over time even in names of well-known companies. We can illustrate this with this graph of the FTSE 100 which shows the market high and low in each year since 2000.
There’s a few ways we can invest in equities, but any investment in this field should ideally be for the longer term.
A few of those choices are:
Investing in an Equity fund:
A great choice owing to their ease.
With equities you want to use diversification (I.E hold a range of different equity in companies with a range of characteristics) as it’ll smooth out your gains and losses into a more consistent return over time.
By buying into a fund, you essentially purchase a pre-made pool of stocks and so get the benefits of this for you.
There’s a few different options when it comes to funds. You can either choose a passive or active form of management.
An active fund is run by an individual or team of individual professionals who pick stocks based on their market experience, and research how they might be able to beat the market based on their knowledge of the companies they invent in.
An index fund is designed to simply hold a variety of stocks under a pre-defined criteria. and sticks to it. For instance a type of index fund known as a tracker might simply hold all stocks in the FTSE 100 index and try and replicate it’s performance. Others might offer stocks only in the major currency. With the criteria in place, the need for investment decisions is very limited and often automated.
So which is better, index or active? Well that’s something of a controversial topic in financial markets! Naturally as humans we tend to be drawn to active funds, as the idea of someone making conscious choices based presumably on logic sounds much more intuitive than a pre-set criteria.
The body of evidence however generally suggest index funds in a general sense tend to do slightly better. (This is largely because the costs of running an active fund are generally higher, so after adjusting for costs and fees the gain can be bigger).
We wrote an article on passive vs. active funds here if you’d like to learn more about this debate.
Whilst you can buy and sell a position in a fund, you really should look at this ideally as a much longer term investment. You should also be aware that some funds have restrictions on how quickly you can withdraw funds and should check if there’s any restrictions on this.
Investing in Equity through Private Wealth Management:
With this option you basically hire a professional to research and manage a stock portfolio specific to your needs.
There are advantages to this – a good wealth manager will take into account your specific circumstances directly and help you plan for life events, and take into account any investment priorities you have. They’ll also thing about how to optimise your investment by taking into account matters like tax planning.
As you can imagine, this one is at the top of the tree in costs – but can be worth it if you get a really good manager who can justify the rate of return. Unfortunately a good few can’t and a scary number don’t even beat the market before costs, so you need to pick a manager with great care……
Investing directly in an equity:
You can of course buy shares in a single company through a brokerage service. For a novice investor, the funds route is a lot safer – if you are going down this route you need to think about diversification, as you can end very exposed to market movements – not something to do lightly with your life savings.
And finally:
Alternative Investment Products
Wine/whiskey/bitcoin/cyptocurrency etc:
Your investments are always a choice for you, but I will just observe these types of investments have very high risk characteristics and rarely end well except through good fortune or deep expertise.
From the beginning of time people have wanted to invest in something they feel they like or even have a reasonably good knowledge of.
To be able to make money (consistently) in these fields is something that’s specialized and you need to have a fundamentally detailed understanding of to make anything other than unreliable short term gains. It’s ended in tears for many – don’t be tempted. Just enjoy drinking your wine instead!
Considering investment products against risk profile.
With any investment you obviously need to think about your personal circumstances as well – the next post in this series deals with some ideas of how to understand what level of risk you’re willing to take.
Hannah over at Koody has a page on the best investment platforms which may provide some ideas on services you can use.
Any questions?
Choosing the right investment products can feel overwhelming. If you have general questions on products please do ask in the comments below and we’ll do our best to help!
Please note we can’t provide personalised advice as it needs to be built for your specific circumstances – you should contact a reputable financial advisor if this is your end.
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And that’s it!
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