Like a savings account or an ISA, an investment is a way to get a return from your money.
However, with an investment there is an element of risk. While you could earn a far greater return on your money than with cash savings, the risk is you may not earn any interest or even get your original investment back.
There are different types of investment available, and knowing which is which and choosing between them can seem very confusing. On the most basic level, you can invest in four main asset classes:
1.Shares (also known as stocks)– you buy a stake in or 'share' of a company, and the value of your investment grows or falls as the value of the company increases or decreases. You may also receive a dividend from the company's profits, depending on the company you invest in. Shares are deemed to be the riskiest of the four asset classes – their value can fluctuate significantly – but alongside this increased risk is the potential for a far greater return. Some shares, sectors or stock markets are deemed more risky than others. Find out more about shares.
2. Bonds and gilts - with a bond, the money you invest is given as a loan to a company or, with a gilt, to the government. As a lender, you are paid interest on the loan amount, and as such, bonds are more suitable if you require a regular income, rather than long-term capital growth. The main risk associated with bonds is that the company may not be able to pay back their loan. Bonds are credit rated with higher risk bonds (junk bonds) paying higher interest rates. Bonds where the money is lent to the government (known as gilts) are considered to be safer and therefore generally pay a lower rate of interest. Find out more about bonds and gilts.
3. Property - with a property investment, you can invest in the purchase of a property, and refurbish it to a standard that makes it more valuable on the property market and sell it. Or you choose to buy to let, and therefore can stand to receive a regular income in the form of rent from a tenant – commercial or residential – as well as long-term capital growth if the property increases in value.The potential risks associated with investing in property are the ups and downs that can occur in the property market, as well as the chance that a tenant may not pay their rent. Find out more about investing money in property.
4. Cash - cash is an asset class. Cash is used for savings with a bank or building society, either readily accessible or locked in for longer periods.
You can go it alone and invest in any or all of these asset classes by yourself, or you can opt for what is known as a pooled investment, where you invest as part of a group and the investment is controlled by a fund manager. These may be in a single asset class or across a range of these asset classes.
Pooled investments include Unit Trusts, OEIC (Open Ended Investment Company) or Investment Trusts. But there are a huge range of pooled investments available to choose from, to suit different kinds of investors. There are also specialist funds available if you're looking for an ethical investment, or to invest for a child.
You can also put a tax wrapper around certain investments without having to pay any Income Tax or Capital Gains Tax. The same is applicable for pensions, and you are able to claim tax relief on the pension contributions going into the policy. Find out more about investment and tax.
Risk is an inherent part of investing money, and it's important to remember that risk and reward are interconnected. The greater the risk you take with your money, the bigger the potential reward and, conversely, the safer the investment, the lower the return is likely to be.
Investments and the investors they are aimed at are typically split into three categories of risk:
1. High risk - typically a high risk investor would be someone who has very good knowledge of investments, who wants to achieve the biggest returns possible, or somebody with a high income or significant assets who can afford to take more risk. High risk investors may put a high proportion of capital in stocks and shares, because although this is a more volatile asset class, it has potential for the greatest rewards.
2. Medium risk - medium risk investors might be those starting to near retirement, somebody who has less time to invest or wants to take a smaller amount of risk. A medium-risk investor would generally diversify their investments, i.e. shares, bonds, property and cash, while still trying to maximise returns.
3. Low risk - a low risk investor would typically be an older person who is approaching retirement, or is already retired, somebody who needs an emergency fund or someone who does not want to take any risks with their money. Low risk investments are deemed to be cash (for example investing money in a savings account) or government bonds, rather than stocks and shares, as a way of providing a regular income or capital preservation, rather than building investment capital.
The amount of risk you should take with your investment is personal and will depend on different factors, but should ultimately come down to how much you feel you could afford to lose if the worst were to happen.
The risks associated should be fully explained to you before you invest so that you feel clear about what you are signing up for.
One way to minimise the risk of investing money is to diversify - spreading your money across different investments means the likelihood of losing all your capital is significantly decreased. It is important to remember that risk can be reduced, but not eliminated altogether by diversification.
Different types of investment come with different costs and charges.
Depending on the type of investment you choose, you may have to pay upfront charges, surrender penalties, switching fees, dealing or transaction fees and interest penalties if you cash in early, to name but a few.
Investment providers will give you information about the possible returns before you sign up, which will take into account the impact of any charges on the return you stand to get.