Investment Advice

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Investments can be funded in 2 ways: Either from existing capital which is not wanted for another period, or from regular savings out of income.

There are several things that should be considered when the opportunity to invest money occurs, the main one of which is your attitude to investment risk.


Attitude to Investment Risk.

Risk versus Reward. How much risk am I prepared to accept for the prospect of a greater return (reward) on my investment. This will be flavoured by several things -not least your own family and personal background, but you should always give great weight to the notion of how likely (or otherwise) you consider your chances of having another similar size lump sum to invest. Basically, the less likely one is to benefit from a repeat, the more cautious you ought to be in how you invest as that is the way to protect your funds.

Consider;

• Like everything else in life, all financial planning carries some degree of risk.
• You should tailor your own investments to match your personal risk/reward profile.
• The greater the risk the greater (usually) is the potential reward…and the greater the potential loss.
• Your main objective should be to always achieve a real rate of return...i.e. a positive return after accounting for tax and inflation.
  
  There are 3 main assets classes;
  ~ Cash
  ~ Corporate and government bonds
  ~ Equities.

Let's look at each one in turn:

CASH.

This is good for short term funds. Always retain sufficient in your bank to pay for immediate needs and household bills covering a period of, say, the next 3 months. Include in this figure any large purchase you might have planned. This is referred to as contingency planning or emergency fund. Of course, if we plan properly there is never an emergency.

Generally cash investments carry a lower volatility than other asset classes. In other words they are less likely to show a fall in value in real terms. However, over a long period of time the chances are that the effects of inflation will be to erode the value of cash funds at a higher rate than other equity based funds, so if you are investing for a longer period you should always consider pooled equity investments for a high proportion of the total available.

CORPORATE and GOVERNMENT BONDS.

These invest in either private publicly quoted companies or the British government of the day.

In each case they are a prime way of that institution raising capital by borrowing so for the individual these are essentially loans.

The risk profile is higher than that of cash as you are lending your capital to a specific company. If that company has poor fortunes or goes bust, your capital is at risk.

With the British government the risk is perhaps slightly different insofar as it has never yet reneged on a loan as it simply issues another stock to repay the one that is maturing.

EQUITIES.

These invest in the stock market. There are several ways of doing this; either singly in one or a limited number of companies, or as a pooled investment in a unit trust or open ended investment company (OEIC.)

The inherent risk with this type of investment is that the value of the underlying shares can fall as well as rise. The risk is therefore higher than with other asset classes.

Historically these are considered better for long-term funds as over time, they usually out-perform other modes of investment. The obvious caveat with that statement though is the price of the shares at the time you might have to sell. If, even after 10 years you have to sell your portfolio for a specific reason and the FTSE index has just fallen, then the chances are that your gain will not be as high as it might otherwise have been. You might even make a loss. The only advantage of making a loss is that you can offset that against any profits for Capital Gains Tax calculations. Hardly encouraging is it?

 
Other Considerations.

1. Tax efficiency. Is the return tax free? Remember with a cash Individual Savings Account (ISA) the interest earned will be free from Income Tax or Capital Gains Tax. These, then are more attractive to higher rate tax payers. On stocks and shares ISA’s tax will be due on the dividends so the fund will not now grow as efficiently or quickly as it did before Labour started to spend too much. Never forget to top-up your pension planning if you are self employed or if you have under-funded your scheme.
2. Do I need income, capital growth, or a combination of the two? This will have a real significance in deciding in to which fund you invest. Are you about to retire with the subsequent reduction in income? Will you have a further lump sum to invest from your occupational pension scheme? Are the children likely to go on to further education and if so, how far away is that likely to be.
3. Length of term for investment. The factors here might be your age (length of time to retirement.) The likelihood of further education for children. Changing the car; usually 3 – 5 years so short-term.
4. Purpose of investment. Is the purpose requiring a certain figure which must be attained. If you require a particular sum for a specific purpose then you might need a guaranteed growth rate. That would determine a particularly cautious investment. Perhaps you already have the sum required but are simply looking to invest it for a period with the aim of maintaining that level of capital.
5. Am I a novice investor or more experienced? How familiar are you with the terms used or where the underlying investment is held. Can you trust the company or advisor with whom you deal. If you are a person who will look at the performance of a fund more frequently than perhaps every 3 months consider whether or not that particular investment or fund is right for you.
6. Always consider that once you have invested and made your decision the original aims and performance of your money should be monitored. As a general rule the older we get, the more cautious we become. Always have periodic reviews.

There is no hard and fast rule for this, but it is generally accepted that the following proportions be applied when deciding how much/ where to invest. Please further note that these percentages are after allowing for contingency planning, and reducing any outstanding unstructured debts.

Cautious Attitude to Investment Risk

Balanced/ Medium Attitude to Investment Risk

Speculative/ Higher Attitude to Investment Risk

These are intended as a guide only and the individual investor must be content with his/her own mix.

In the tables above we have introduced the concept of fund sectors. I will explain these in more detail below. As a general rule the higher the number of the sector, the higher is the risk associated with an investment in that sector.

It has not been intended to provide specific funds recommendations in this article. Over time even the fund sectors are refined and amended as experience is gained and the performance of different funds alters.

As with most things, it is worth taking advice on this – especially if you are less experienced at investing. With the plethora of websites available it is easier than ever for the more experienced investor to do the whole job himself and thereby save the commission. At perhaps 7% of your total investment sum, the commissions can be quite substantial!

NB
Please be aware that, unless you invest in a cash investment such as a traditional bank account or a Cash Mini Individual Savings Account, your investment sum can fall as well as rise in value.

If you invest yourself witho ut taking advice, then there is no consumer protection offered by the Financial Services Act.

On a scale of risk consider the following table;

Glossary of terms.

ISA Individual Savings Account.

UK Gilt Loan to the British government or a ‘blue chip’ high standing company

OEIC Open-Ended Investment Company

Unit Trust A managed fund in a pooled investment.