Choosing the right investment for your needs depends on your current financial circumstances, and crucially, what type of person you are when it comes to taking, and accepting risk.
First you must decide what you want to achieve from your investments. Are you seeking to enhance your income in retirement (say), increase the value of your capital to fund your family's future (say), or, more probably, is it a mixture of the two? If, as is highly likely, it is this mixture, then what is the overall balance of your particular requirements?
There are many different types of investment open to you with varying degrees of possible reward and, consequent, investment risk. In the majority of cases the more speculative your investment, the greater the potential reward BUT also significantly greater the risk to you achieving it.
You will soon notice as you begin your research, some investments provide income in the form of regular dividends, whilst some produce very little income. In the latter case this is likely to be because the company is still quite young. Its profits are being re-invested in the growth of the business, not paid out to shareholders as dividends. The expectation is for enhanced future capital growth to reflect the company's potential development and business success.
There are some investments that are more suitable for you if you have a large pot of capital to invest. Whilst there are other investments such as collective funds, that are ideal, if you have limited capital and restricted knowledge on how to invest it.
The golden rules to your investment activities
You might be one of those people who regard directly buying shares in companies listed on the stockmarket as the riskiest way to invest your savings. This need not be the case. Here are some golden rules you should consider when investing in companies shares: -
- Don't put all your eggs in one basket. Buy shares in a number of different companies and from different industrial sectors of the market. If one share, or one sector, performs badly, then you have balanced this with the gains you are hopefully making in your other companies and sectors.
- Take the long term view. Five year is the sensible view as to the time you might hold your investment to maximise your gains.
- Don't pay too much attention to the daily fluctuations of stockmarket prices. If your reasons for originally selecting the company appear sound, and nothing has happened to adversely affect its value and performance over your 5 year time span, than it can be safe to assume that today's adverse fluctuation will swing back tomorrow or the day after.
- Try to limit your broker charges. These should be no more than 1.5% to 2% of the total value of your order. If they are significantly higher than this, then your investment has to grow by a significant amount to cover these costs and put you into profit! Remember, this is now a very competitive business area. Charges are under pressure and online Internet trading facilities have increased the pressure and further reduced your likely dealing costs.
- Reinvest your dividends. Compounding the size of your investment in this way will significantly increase the value of your portfolio.
- Try to establish a spread of investments. As a general rule, you should aim to hold shares in at least six different companies in your portfolio at any one time. Remember, your first selection is likely to be your most favoured company, and after you have chosen six you are likely finding it harder to select a specific company to invest in from a range of alternatives.
- You can limit risk by buying shares in ‘blue chip' larger companies. Large, well established companies with a good reputation should maintain their value over the longer term. Although there are always exceptions to the rule!
Collective investments are share-based products run by professional investors aiming to spread the risk over a wide range of different companies and, probably, industries. If you have a limited amount of money to invest and are cautious as to your own investment skills, then these investments can aid you to quite significantly spread your risk. They can be a particularly useful vehicle if you are a new investor still learning your way around the stock market and with limited capital to invest. However, a disadvantage is that their performance will rarely match that of a winning individual company share. Against this there are less likely to be extensive losses through your investment with them.
There are a wide variety of such investments available to you. They cover investments in anything from UK blue chip companies, which might suit the novice investor, to more speculative newly listed companies and overseas markets which might suit you if you are a more experienced and confident investor who lacks the resources to adequately research these specialist areas.
Investment trusts are companies that invest in the shares of other companies and, consequently, provide a wider spread of investment and, therefore, risk. You buy shares in an investment trust in the same way that you buy shares in any other listed company. The price of your share is determined by the demand for shares in this specific investment trust company, as well as the underlying value of its investments.
Unit trusts are funds, again managed by professional investors, who also invest in the shares of other companies. You purchase units in the trust and your investment is then pooled with other investors to buy shares, thus spreading the risk across different companies, industries and overseas markets. The future price of your units is dependent upon the value of the overall portfolio that the manager is running and not the demand for the units in the trust itself. Units are acquired directly from the management company, and are not traded on the stock market itself.
Open ended Investment Companies (OEIC's ) are a fairly new form of collective investment for UK investors. Changes in the law in the UK now make it possible for investment companies to create OEIC's, which have operated for several years in the USA and Europe. An OEIC is similar to a unit trust in that the number of units increase or decrease according to demand. However, like an investment trust, the investment is held in a company and units are purchased or sold at a single price. Units can be brought direct from the OEIC manager, or through a third party such as your stockbroker or IFA. Many unit trust managers are, in fact, now converting their original unit trusts into OEICs'.
If your investment requirements are for regular predictable income and your primary concern is not whether the value of your investment increases over time, you might need to invest at least part of your portfolio in gilt-edged stocks.
Gilts are issued by the government to raise money to finance its activities. They are issued at a cost of £100 per unit, which is the face value of each individual stock. Investors receive a twice yearly interest payment, based upon the rate specified at the time the stock was issued. The government promises to buy back the stock, at its original face value of £100 per unit either at a stated future date (e.g. 8% Treasury 2021 stock pays an interest rat of 8% per annum in two instalments, and will be re-paid by the government in 2021).
The value on the stock exchange fluctuates dependent upon moves in interest rates, inflation and views as to the economic performance and future of the government. Prices rise when interest rates are expected to fall, falling when interest rates are rising. Thus our 8% Treasury stock might be valued at £140 per unit when underlying interest rates are below the 8% the government is contracted to pay on the stock.
In times pf high inflation gilts are less attractive, as inflation eats into the real value of the gilt's redeemable value. In other words your purchasing power of the £100 unit will be less on repayment than it was when the stock was originally launched.