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Investments
Investments can be a great way of making a better return on the savings you have, but it's important to understand how they work. There are risks involved that mean you could lose out. Learn more about investments and compare stocks and shares ISAs.
Before you start investing it's a good idea to have saved up three to six months’ worth of household bills and expenses in an easy access or instant access cash savings account. You should be able to access this cash without notice, in case you have a household or financial emergency.
Once you have the bills covered, think about reducing or paying off debt. The interest rate on credit cards and loans can be much higher than the return you would get from cash or other lower risk investments.
When you feel that you have your money situation under control, you can start to think about investing for the future. Money that you put into investments should be medium to long term money, not cash that you might need to get your hands on quickly.
What are investments?
Investments are methods of getting your money to work harder for you than cash savings. They describe lots of different products, or asset classes, that you can use to get a better return than cash.
As with any regular savings account, different investments are alternative ways to get a return from your money.
However, investments come with an element of risk – while you could end up earning a far greater return on your money than with a tax-free wrapper on your savings account, you may not earn any interest at all or even get your original investment back.
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The main types of investment
There are many different types of investment available. In addition to cash and cash-based savings products, you can invest in four main asset classes:
Stocks and shares
When you buy a stake in, or 'share' of, a company, the value of your investment grows or falls as the value of the company increases or decreases. In the UK the stock of a company is made up of individual shares. In the US it’s just called stock. They are listed and traded on stock markets. London’s is called the London Stock Exchange.
The value of a company’s stock is dependent on a lot of different factors. These could include how its sales are doing, how the economy is performing, whether rivals are offering a better product, and whether taxes and regulations are likely to affect its profits. The markets are fickle and unpredictable and values can rise and fall on a whim.
You get capital growth when you sell your shares for a higher price than you paid for them (and losses if you sell at a lower price). While these shares are being held for you – but not sold – the nominal price increase is considered to be capital growth, even though it is on paper only.
When you own shares, you may also receive a dividend from the company's profits – called revenue. Some investors and investment vehicles reinvest this revenue to increase the capital. Others take the revenue as income.
Not all stocks offer the same rewards or risks and different stock markets specialise in different types of companies. A portfolio of stock investments might include some ‘blue chip’ companies, different firms operating in a variety of sectors, firms listed on different stock markets and different geographic regions.
Bonds and gilts
With a bond, the money you invest is given as a loan to a company or the government. As a lender, you are paid interest on the loan amount until the original loan is repaid. This makes bonds more suitable if you require a regular income, rather than long-term capital growth.
The government issues bonds when it needs to borrow money, and these are known as UK government gilts. Gilt investments are regarded as very secure because they are backed by the government and will always be repaid.
Bonds are considered less risky than shares, because if a company were to get into financial difficulty, it would be the bondholders who would be paid before the shareholders. However, bond investments are not as low risk as cash, because there is always the risk that the company may not repay its bond. With cash, so long as your money is in a bank or building society, which is part of the Financial Services Compensation Scheme (FSCS), your deposit will be protected up to £85,000 if the provider were to go bust.
If a company goes bust and it cannot pay its bondholders, they lose out. This is the risk you take with company or corporate bonds, versus cash deposits. Bonds are credit rated to show those with the least risk and those where there is a higher risk of default. The higher risk bonds – sometimes called ‘junk bonds’ – pay out higher interest rates.
Property
With a property investment, you stand to receive a regular income in the form of rent from a tenant, as well as long-term capital growth if the property increases in value - find out more about investing in property.
Property can be a great investment if you buy in the right place at the right time. But you have to factor in that property is more cumbersome to buy and sell than stocks, shares or bonds. And you will have to pay tax on any increase in its value if the property you are selling is not your main home.
You also need to bear in mind that a rental or holiday let will need to be maintained, and you will need to pay council tax and possibly management fees to a letting agent.
There may be times when the property is empty (void) but all your costs, including a mortgage, will still need to be paid.
Funds
All the above forms of investment are also available via a range of pooled funds. This means you do not own the underlying assets direct, in your name, but have units within the fund.
You can choose the type of fund to suit your need or risk appetite but you rely on the fund manager to make the investment decisions for you. Most pensions are run like this.
Funds include:
Bond investment funds
Exchange Traded funds (ETFs)
Insurance company funds
Investment trusts
Open-ended investment companies (OEICs)
Pension funds
Property funds
Tracker funds
Unit trusts
How do I choose the right investment?
The right investment is the one that will help you reach your financial goals, and which doesn't put your money at a greater risk than you feel comfortable with. If you can't afford to lose any of your initial investment (your capital), then cash or gilts is your best option.
If you can afford to tie up your money for a while and are prepared to take a bit of risk, you could opt for bonds and bond investment funds. If you're looking for a better return on your money and you want your investments to have some protection against inflation, then you could consider stocks and shares.
However, these carry more risk to your capital and you should be prepared to ride out the ups and downs, and for this reason they are really suitable only for a medium to long term investment plan.
Most investors have a balanced portfolio, mixing different asset classes that often perform counter-cyclically - when one asset does badly, the other tends to do well. As investors get older they tend to move assets from higher-risk assets classes to lower risk, more stable classes.
How do I know what investments are right for me and where should I invest my money?
Start by thinking about what you want to achieve with your investments. If you're saving for a holiday or house deposit, you don't want to take too much risk with your capital or tie it up for too long, so cash is your best option.
If you're saving for your retirement, then you can afford to be a bit more adventurous and consider stocks and shares or property. Remember to review your progress regularly to ensure you're right on track to achieve your goals.
You could use the services of an independent financial adviser if you feel that a holistic review of your finances would help you decide where to put your money. They will ask you about your attitude to risk and how much of your money you feel comfortable potentially losing if the markets move against you.
How can I make money investing?
One of the best ways to make money when you are investing is to add to your investment at regular intervals. Rather than trying to time the market, you could buy shares in an investment fund every month. Over time, this helps to smooth out the ups and downs of the stock market.
If you're investing in property you need to research your area and market very carefully before you go ahead with the purchase. Talk to people who understand property investment. Be clear about what you're trying to achieve and who you will be letting to.
Property letting can be a reliable source of regular income, but you need to factor in lettings costs, maintenance, damage to the property by tenants, insurance costs and other ongoing expenses.
There are many different investment strategies that people follow. There are active investors who try to force companies to change policies and passive investors who choose firms they think are well managed and leave the bosses to get on with it. There are ethical investors who avoid certain sectors and impact investors who choose firms that will make positive changes. You‘ll need to work out your priorities.
What are tax wrappers?
Tax wrappers are another name for products that you can use for medium to long term savings, where your money can grow free of tax. Individual Savings Accounts (ISAs) and pensions are good examples of tax-free wrappers for your money.
What is an Individual Savings Account?
An Individual Savings Account allows any adult in the UK to invest up to £20,000 in any one tax year (From April 6 to April 5 the following year).
There are a number of different types of ISA including, Lifetime ISAs, Cash ISAs, and Stocks and Shares ISAs. They are a good home for long term money as the interest and capital grows tax-free inside an ISA, and you don't have to declare the details on your tax return.
What is the best cash investment?
It used to be that Cash ISAs offered the highest interest savings account, but now there is little difference in interest rates between ISAs and best buy instant access accounts. The difference is that your money is protected from tax in an ISA, but since most people have a £1,000 Personal Savings Allowance every year, this is not really an issue.
Are premium bonds a safe investment?
NS&I Premium Bonds, also known as National Savings premium bonds, investment or savings bonds, premium savings bonds or just National Savings, are a savings scheme from the government.
They encourage people to save by giving them the chance to win a prize while lending their money to the government. Winning premium bonds numbers are revealed each month when all the bonds in issue go into a prize draw.
National Savings Premium Bonds are not strictly an investment or a savings plan. This is because the Premium Bonds from National Savings and Investments are bonds from the government that don't pay interest. Instead there's a chance to win a prize.
They're very popular because there's no risk to your capital, and the chance to win big. However, you might win nothing at all, which would mean they gave a worse return than a low interest easy access account.
Are you earning enough interest?
It could be time to find and compare stocks and shares ISAs