What asset classes should I invest in?
So what asset classes should you be considering?
Cash on deposit should be the starting point for every investor – aim to have three to six months' expenses in an instant access account for emergencies. Longer-term cash holdings can be held in fixed-term accounts spanning from one year to five or more. Typically the longer you can tie your money up for the better the interest rate you'll get.
Cash is the lowest risk asset class, in so far as you are paid a pre-agreed rate of interest and you won't physically lose any money. It is also protected in case your bank goes under, thanks to the Financial Services Compensation Scheme (to the tune of £85,00 per person, per financial institution).
However there is a big 'but' - interest rates are at rock-bottom and are likely to remain low for some time. This means it's hard – if not impossible – for your money to keep pace with inflation and so over time it's spending power will reduce. So while cash might be perceived as safe, it's not a risk-free investment.
Moving up the risk spectrum we come to fixed-interest securities – these are essentially loans or IOUs made by investors in return for a fixed rate of interest. Loans to companies are known as corporate bonds while loans to governments are known as gilts or government bonds.
The risk, from an investor's point of view, is that the organisation receiving the loan may default on repayments. This means that the greater the risk of default, the higher the rate of interest you'll receive.
While bonds are typically regarded as higher risk than cash and lower risk than stocks and shares, there is a huge variance of risk within the market. Gilts are considered the lowest risk – as a government is unlikely to default. Within corporate bonds you can opt for safer investment-grade bonds, or riskier, but better paying, high yield bonds where there is a greater risk of default.
Providing the opportunity for income and capital growth, property has the potential to be a lucrative investment. And, because its performance is not linked to the stockmarket it can be a great diversifier. Some investors choose to buy residential property to let out – an investment known as buy to let. It can be expensive to buy and costly and difficult to manage however.
Commercial property investments can be easier to access – funds exist that specialise in the sector, buying up a portfolio of properties including industrial, retail, office and entertainment spaces; and the rent paid by the tenants provides a reliable income stream for investors. Leases are also much longer than those on residential properties too, reducing risk and increasing stability for investors.
When you purchase shares you are literally buying a stake in a company listed on the stockmarket. Along with your stake in the firm you also get shareholder rights, including the ability to vote at annual general meetings. The value of the share will rise and fall in line with the fortunes of the company in question. The price of the share will be influenced not just by the physical value of the company but by sentiment too.
Prices tend to rise on the expectation of good news and fall on publication of bad news. In addition to growth in the share price, investors may also enjoy an income stream in the form of dividends – which is a distribution of profits among shareholders.
Share-or equity-based investments are regarded as the highest risk asset class, although of course some shares will be riskier than others.
Just how much money you invest in each area will depend on your attitude to risk. Cash and fixed interest are at the lower end of the risk spectrum, so cautious investors may want to keep more of their money in these asset classes, while those who can afford to take more risk should be favouring stocks and shares.
Suggested portfolio mixes, according to risk profile:
30% UK shares
40% international shares
20% fixed interest
25% UK shares
25% international shares
40% fixed interest
15% UK shares
15% international shares
55% fixed interest
Source: Chase De Vere
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.