Financial Planning: Spreading risk between different kinds of investments
Financial planning for a successful personal lifestyle has no value unless it is properly implemented through an appropriate investment strategy. If you’ve got a sufficient amount of money in your cash savings account – enough to cover you for at least six months – and you want to see your money grow over the long term, then you should consider investing some of it.
Investing is a lifelong process, and the sooner you start, the better off you may be in the long run. Regardless of the financial stage of life you are at, you will need to consider what your investment objectives are, how long you have to pursue each objective, and how comfortable you are with risk.
Current finances and future goals
The right savings or investments for you will depend on how happy you are taking risks and on your current finances and future goals. Investing is different to simply saving money, as both your potential returns and losses are greater.
If you’re retiring in the next one to two years, for example, it might not be the right time to put all of your savings into a high-risk investment. You may be better off choosing something like a cash account or bonds that will protect the bulk of your money, while putting just a small sum into a more growth-focused option such as shares.
Choosing your savings and investments
You may be a few months away from putting down a deposit on your first property purchase. In this case, you might be considering cash or term deposits. You might also choose a more conservative investment that keeps your savings safe in the short term.
On the other hand, if you have just recently started working and saving, you may be happy to invest a larger sum of your money into a higher-risk investment with higher potential returns, knowing you won’t need to access it in the immediate future.
Different types of investment options
If appropriate, you should consider a range of different investment options. A diverse portfolio can help protect your wealth from market corrections. There are four main types of investments, also called ‘asset classes’, each with their own benefits and risks.
> Shares – investors buy a stake in a company
> Cash – savings put in a bank or building society account
> Property – investors invest in a physical building, whether commercial or residential
> Fixed interest securities (also called ‘bonds’) – investors loan their money to a company or government
Defensive investments focus on generating regular income as opposed to growing in value over time. The two most common types of defensive investments are cash and fixed interest.
Cash investments include:
High interest savings accounts
The main benefit of a cash investment is that it provides stable, regular income through interest payments. Although it is the least risky type of investment, it is possible the value of your cash could decrease over time, even though its pound figure remains the same. This may happen if the cost of goods and services rises too quickly (also known as ‘inflation’), meaning your money buys less than it used to.
Fixed interest investments include:
Term deposits, government bonds, corporate bonds
A term deposit lets you earn interest on your savings at a similar, or slightly higher, rate than a cash account (depending on the amount and term you invest for), but it also locks up your money for the duration of the ‘term’ so you can’t be tempted to spend it.
Bonds, on the other hand, basically function as loans to governments or companies, who sell them to investors for a fixed period of time and pay them a regular rate of interest. At the end of that period, the price of the bond is repaid to the investor.
Although bonds are considered a low-risk investment, certain types can decrease in value over time, so you could potentially get back less money than you initially paid.
Growth investments aim to increase in value over time, as well as potentially paying out income. Because their prices can rise and fall significantly, growth investments may deliver higher returns than defensive investments. However, you also have a stronger chance of losing money.
The two most common types of growth investments are shares and property.
At its simplest, a single share represents a single unit of ownership in a company. Shares are generally bought and sold on a stock exchange. Shares are considered growth investments because their value can rise. You may be able to make money by selling shares for a higher price than you initially paid for them.
If you own shares, you may also receive income from dividends, which are effectively a portion of a company’s profit paid out to its shareholders.
The value of shares may also fall below the price you pay for them. Prices can be volatile from day to day, and shares are generally best suited to long-term investors, who are comfortable withstanding these ups and downs.
Although they have historically delivered better returns than other assets, shares are considered one of the riskiest types of investment.
Returns are the profit you earn from your investments.
Depending on where you put your money, it could be paid in a number of different ways:
> Dividends (from shares)
> Rent (from properties)
> Interest (from cash deposits and fixed interest securities)
The difference between the price you pay and the price you sell for makes up your capital gains or losses.
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