Understanding asset classes
There are four main types of investments, known as ‘asset classes’. Each asset class has different characteristics and advantages and disadvantages for investors.
Cash
This involves putting your money into a savings account, with a bank, building society or credit union. Your money may not hold its spending power if inflation is higher than the interest rate. Cash is the most basic of all investment forms. Saving money into a deposit account with a bank, building society or credit union is considered cash saving. Cash can be used to save for immediate needs or as a parking place in between investing in other assets.
Why have cash savings?
If you need instant access to your money or are saving for the near future, cash could be a good option. You earn interest on cash. How much you earn varies from one account to another. You can save in cash without paying tax on the interest by saving in a Cash ISA
What are the risks?
The amount you invest will not go down in actual terms, but you may lose spending power if interest rates you receive don’t keep up with inflation rates while you are saving. In other words, the nominal value of your savings will stay the same, but the real value could fall.
Cash deposits are guaranteed
against the failure of a bank, building society or credit union from 1 January 2016 to the value of £75,000 per person by the Financial Services Compensation Scheme.
Bonds
A bond is a loan to a government or company. In return for the loan, you receive interest and the amount you invested back at an agreed future date. Bonds are issued by governments and companies as a way for them to borrow money. In return, lenders get paid interest and the full value of their money back at a specified date, called the ‘redemption date’.
The market price of a bond will rise as interest rates are expected to fall. Bonds have a fixed interest rate. Imagine you hold a bond with a fixed interest rate of 5% whilst general interest rates fall from 4% to 2%. Your bond would be a lot more attractive when general interest rates are 2%; therefore, its price on the market rises.
What are bonds?
Bonds issued by the UK Government are called ‘gilts’. You can buy these directly at the Post Office or the Government Debt Management Office.
Bonds issued by companies are called ‘corporate bonds’. They are bought and sold on the stock market. Their price will go up and down; this means that if you decide to sell before the agreed redemption date, you may get more or less than the price you originally paid.
The interest you receive from your bond will be specified before you buy. While the end value and annual interest payments are normally fixed amounts, in some cases such as with UK Government index-linked gilts, they may be related to a price index.
Index-linked bonds ensure your money keeps in line with inflation, but, at times of low inflation, a fixed rate bond could provide higher returns.
What are the risks of investing in bonds?
There is still the risk that the issuer may be unable to fulfil its promise to return your money on the redemption date. This could mean that you lose some or all of your initial investment. To help you manage this risk, bonds are rated by credit rating agencies. The rating on a bond is a good guide on how capable the issuer is in paying back their debt i.e. how likely you are to get your money back when the term of the bond ends.
Shares
You can invest in a company by buying shares. In return, you may get a proportion of any profit the company makes (depending on how many shares you hold). Shareholders are entitled to have a say on the way the company operates, including voting at company general meetings.
Companies issue shares, often referred to as ‘equities’, as a way of raising money from outside investors. In return, the investor may receive a portion of the company’s profit, called a ‘dividend’. Investors receive a dividend for each share they own. Shareholders are in effect the owners of a company.
Why invest in shares?
Historically, shares have been one of the highest-performing asset classes over long periods
Dividends are normally paid annually
or biannually
Dividend payments have usually risen over time. But if a company suffers a loss, dividend payments can decline or even stop
What are the risks?
The value of your shares is dependent on a number of things including the performance of the company and the wider economic outlook. The value can go up and down over time. It is sensible to invest in shares only if you can afford to put money away for a period of years. The fluctuating nature of the value of shares means you do not want to be forced to withdraw your money when share prices are low, as you may get back less than your original investment.
Property
Becoming a landlord is a well-known way to invest in property. The aim is to get an income from the rent you charge and that the house or flat increases in value after expenses so you make a profit if you sell it. Land and commercial buildings, such as shopping centres, are other forms of property investments.
Why invest in property?
Property provides a relatively high and stable rental income with the possibility of making your money grow over time.
What are the risks of investing in property?
Buying and selling buildings can take a long time, and if you invest in property you might not be able to withdraw your cash as quickly as you would wish. Investing in property via a fund generally means it is easier to get access to your cash when you need it.
However, providing this level of access can mean lower returns. The value of properties fluctuates over time so there is a potential that you could lose money.
You can invest in property by buying a property on a buy-to-let basis. However, the cost and complexity of owning and managing an individual property is high.
There are two ways to invest in property
indirectly:
• Invest in shares of companies that own or develop properties
• Invest in a property fund which gives you exposure to a range of assets. These may include property company shares or commercial property, such as offices, shopping centres
and warehousing