Long-term investors rewarded by compound performance
An investor who puts money aside over the long term for the proverbial rainy day is far more likely to achieve their goals than someone looking to ‘play the market’ in search of a quick profit.
The longer you invest, the bigger the potential effect of compound performance on the original value of your investment. Many investors will be familiar with the term ‘compounding’ from owning cash savings accounts. The term refers to the process whereby interest on your money is added to the original principal amount and then, in turn, earns interest.
Over time, compounding can make a significant difference. Your investments can benefit from compounding in a similar way if you reinvest any income you receive, although you should remember that the value of stock market investments will fluctuate, causing prices to fall as well as rise, and you may not get back the original amount you invested.
Shares, bonds, property and cash react differently in varying conditions, and opting for more than one asset class can help to ensure your investments won’t all rise or fall in value at the same time. Holding a portfolio of investments as part of a collective investment scheme can help to diversify the perils associated with investing in individual assets and markets, as well as less visible hazards such as inflation risk – the possibility that the value of assets will be adversely affected by an increase in the rate of inflation.
Investing in vehicles such as unit trusts, investment trusts and OEICs can also remove a lot of the difficulty associated with managing a broad portfolio. Above all, investors should aim for a level of risk they are comfortable with which reflects their investment objectives.
Types of collective investment scheme
Unit trusts pool funds together under one umbrella and then manage them en masse. Investors pay into the unit trust, which then buys assets such as equities or bonds on their behalf.
The monetary value of these assets is divided by the number of units issued when the fund is created to give an initial unit value. This value then fluctuates as the underlying assets trade daily and investors put money in or take money out. As there is no limit to how many units can be created or redeemed on an ongoing basis, unit trusts are known as ‘open-ended funds’.
An investment trust works along the same principle of raising money from investors to buy assets that it manages on behalf of them all. The main difference is that the investment trust is created by selling a fixed number of shares at the outset. As no new shares are created, investment trusts are known as ‘closed-end funds’.
Open Ended Investment Companies (OEICs)
OEICs are a mixture of a unit trust and an investment trust. OEICs issue shares rather than units but have a different pricing structure to unit trusts. OEICs are based on a single price structure which means buyers and sellers receive the same price.