You have probably already realised what a vast array of investment options are out there for you to take advantage of. We are here to help you make sense of it all in a way that makes it easy for you, and personal to your needs.
Investor Profile specialises in offering honest investment advice that will make sense to you.
Below is a summary of some of the important topics that are fundamental to investing.
Choosing the right investments
Risk and return provide the foundation for making good investment decisions. But when choosing the right funds to invest in for the long term for yourself the two most important considerations other than risk and return are your own risk profile – your investor profile – and the need to spread your risk.
The reason you would need to understand your own investor profile is to ensure you put together a set of investments that are in keeping with your needs and your personal characteristics.
One of the golden rules of investing is to spread it around. Otherwise known as diversifying your risk it means you don’t want to put all your eggs in one basket, because that basket might get snatched.
The other more obvious reason why you would not want to invest in just one or two sectors is that you don’t know which sectors will perform best. That’s right. Nobody knows for sure which sectors will perform best in the short term, or even less so in the long, term.
Risk
Managing risk is about getting the right balance with your investments. You are more than likely to already hold one or more of the investment products listed below. But what is important is to hold enough different types of investments in the right proportions that is in keeping with your lifestyle and requirements.
Here is a quick guide to where different investments might sit on a scale of risk.
| Risk | Example Investments |
| High | Direct holding in one or a few shares |
| Direct holdings in a larger number of shares | |
| Equity Funds e.g. Emerging Markets | |
| Equity Funds e.g. UK and International | |
| Managed Funds | |
| Property | |
| Gilt (i.e. Government bonds) and Corporate Bond Funds | |
| Savings Account/Cash ISA | |
| Low | Directly held Gilts/National Savings & Investments |
The above investment types are not an exhaustive list but help to illustrate the general principle behind investment choices based on an undetermined time period for investment.
This table is only a general indicator of relative risk and does not relate to specific circumstances, where risk can vary depending on the relevant market conditions at the time.
Two important concepts that the above table also does not address are those of volatility and the relationship between risk and return.
Unit Trusts/OEICs
Unit Trusts and OEICs (open-ended investment companies) are a form of collective investment fund. The other main types of collective investment fund are investment trusts and exchange traded funds (ETFs).
The basic idea behind collective investment funds is that individual private investors send the money they wish to invest to an investment manager who pools everyone’s money in to one fund and invests this across a range of suitable investments.
The gains made on shares within the fund are free of capital gains tax to allow you to make the most of your investment.
So for a relatively smaller investment amount the investor can benefit from a very diverse spread of investments. This is because the fund, when all investors’ money has been pooled together, can be worth millions of pounds. So the range of shares the fund can invest in is far greater than the range of shares the individual investor could have reasonably invested in.
Investor themselves can further improve their own investment holdings by investing in different funds across different sectors and potentially own 1000’s of shares in a very simple and easy to manage way, without having to manage a portfolio of shares themselves.
Unit trusts and OEICs invest in all sorts of different sectors and industries, which enables you as the investor to put together a group of funds that really suits you.
To give you an idea of the sort of investment sectors out there below is a list of the official sectors as determined by the Investment Management Association.
Active Investment Funds
Active management, or active investing, is about trying to beat the market. It is about exploiting inefficiencies in the market’s ability to price the value of an investment, e.g. the price of a share. The perceived inability of the market to value an investment will lead a fund manager to either buy or sell depending on whether they feel it is under-valued or over-valued respectively.
Fund managers will use a range of techniques to determine whether an investment is worth buying or selling, and at any one time will hope that they hold a portfolio of investments that is capable of beating the average returns of the market they invest in.
The two major factors any active fund manager will rely on to beat the market are fund selection and market timing. If they can pick the right investments and decide to buy or sell them at the right times then they will be doing very nicely.
In order to try to achieve this goal fund management companies invest heavily in research. Fund management companies go to great lengths to undertake meticulous research on potential investment opportunities. They then analyse this research and eventually arrive at a decision as to whether to buy or sell.
Advantages of active management…
One of the benefits of choosing an active investment strategy is simply the choice of funds available. Although this can be a drawback as well, as highlighted below, you are sure to find a fund, or range of funds, out there that will suit your specific needs as an investor.
Some people feel more comfortable knowing that their money is being managed by a fund manager.
Indeed a small number of funds have a strong long term track record of performance where they are managed by so-called star fund managers.
Disadvantages of active management…
In practice actively managed funds show a wide variety of results and with the vast array of choice now available to investors picking those funds that will perform better than the market is notoriously difficult. In the short term there are actively managed funds that will beat their own sector average (their benchmark index e.g. FTSE All Share Index).
Another significant feature of active funds is their costs. For actively managed funds costs can vary and can be as high as 5-6% on initial investment.
Many people like to know there is someone in charge of their money trying to beat the market. However with such high initial charges there is a lot of pressure on the fund to provide significant performance to justify the costs involved.
Passively Managed Funds
Passive investment management, or passive investing, is about earning the market rate of return. That is, to mirror the movements of an index, e.g. FTSE 100, so that the fund achieves the same growth over the long term as the index itself.
It involves making as few investing decisions as possible and automating the decision to buy or sell investments. This is to drive down the cost of running the fund and therefore the cost to the investor of investing in and holding the fund.
The most popular type of passive fund is the index tracker, or index tracking fund. The idea of these funds is that you buy into a whole sector, or sometimes referred to as an index or asset class, such as the FTSE All Share, rather than just some of the individual shares within that sector, on the basis that you will capture the market rate of return.
If you only choose to buy certain shares within the sector you will have to make a judgement call on what to buy and when to buy them, and then wait to see whether the combination of shares you chose perform better or worse than the sector itself – this is known as active management.
Advantages of passive investing…
When people invest in equity markets over the long term what they are really looking to do is capture the growth of the markets. They want their money to work for them and earn the growth that has historically been achieved. Passive investment management will do this.
Index tracking funds are an effective, cost-efficient way of investing in the markets over the long term without the hassle of worrying whether you have chosen the right fund.
There is also much evidence to suggest that actively managed funds do not outperform their benchmark index (i.e. they do not do their job) over a long period of time. Therefore the charges related to these funds cannot be justified and the majority of investors would be better off investing in passive funds.
Exchange traded funds (ETFs) are also an extremely popular way of investing in passive investment funds. These are structured in a different way to normal unit trusts. They are funds that are quoted on the stock exchange and so are easier to buy and sell as they are priced and traded throughout the day.
ETFs also offer a wider variety of sectors than the normal choice of unit trust index trackers would offer. An investor looking to put money in to more exotic sectors e.g. commodities, could do so passively using ETFs. However there are certain risks with ETFs that are not necessarily present with other types of funds so do be careful if selecting these types of investments yourself.
Corporate Bonds
When companies need to borrow money one of their options is to borrow money from the public. In return they issue an IOU – a corporate bond. When you invest in a bond you are lending the company money.
Similar to any other loan, these corporate bonds are offered to the public with a rate of interest payable to the investor (the lender) and a promise to pay back the money at a certain date in the future.
However with any company there is always an element of risk that they may not be able to pay back the loan. For this reason they need to pay a higher rate of interest to investors in order to attract enough to make the issue of the bond viable.
The companies that issue bonds are given a rating by ratings agencies such as Standard and Poor’s to give investors an idea as to how risky a company is likely to be. Ratings range from AAA through to D.
Once the initial bond has been issued to the public the individual holdings can be traded on exchanges just like shares.
However because the corporate bond market is much larger and more complicated it is quite normal for individual private investors to purchase bonds through a collective investment fund such as a corporate bond fund, usually named bond funds or fixed interest funds. These tend to be relatively high income producing funds that are intended for stable returns and low capital growth.
Government Gilts
When the UK government needs to borrow money one way they do this is to issue gilt-edged securities to the public. These are the same as an IOU. So when you buy gilts you are effectively loaning the government money.
The original issue of any new gilt is managed by the Debt Management Office (DMO).
Just like a normal loan there is a redemption date, the date on which the government will pay you back, and an interest rate, where the government pays you interest for loaning them money.
The rate of interest set for the gilt, known as the coupon, will be in line with borrowing rates at the time of issue.
The naming of gilts is based around the nominal interest rate payable and the maturity date set on issue. So for example a typical gilt would be called 8% Treasury 2015.
Because UK gilts are a loan to the government they are seen as being virtually risk free. The UK government has never failed to pay back a loan or make an interest payment on any gilts.
They are traded on an exchange just like any other stocks and shares to allow investors to buy and sell these gilts at a fair market price as and when they are needed.
When gilts are issued and redeemed they have a par value of £100 (known as their ‘nominal value’) and so gilts tend to trade somewhere around this price while they are on the open market. This way the investor knows that if they purchase a gilt at £97 and hold it to maturity they are guaranteed to make a capital gain on their investment.
The rate of interest payable varies depending on the price of the gilt, but if they are bought and held to maturity it is possible to know exactly what your return would be from the investment both in terms of the interest payable and the final capital gain/loss. This combined return calculation produces a figure known as the redemption yield.
Interest is payable twice a year and the payments are made gross but are liable to income tax. Capital gains made on gilts are free of capital gains tax.
