Investing (for the longer term)
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Putting money away for the longer term usually means investing your money in schemes or funds based on the stockmarket.
When investing, you take calculated risks to increase your chance of getting higher returns on your money, especially over the longer term (money you can afford to tie up for five years or more).
There are different types of investments but, basically, you take a risk with your money by investing in assets (usually on the stockmarket) that could rise or fall in value.
There is no guarantee you will make a return on your investment or even that you will get back the same amount you invested in the first place.
The upside is that you often get a greater return than you would with savings, giving you better protection against inflation over the long term.
What are investments?
A good way to understand investments is to think about investing in three layers.
The First Layer
The first layer, common to all forms of investment, is the underlying investment itself. It will fall into one of four asset classes. These are:
- shares – a stake in a company;
- bonds – loans to a company or the government;
- property – either commercial or residential; and
- cash
You can invest in any one of these asset classes. However, it’s usually a good idea to spread your investments over different classes and providers so that you reduce the risk of losing more of your investment if the value of those assets go down.
The Second Layer
The second layer is called pooled investments – and provides a relatively easy way of spreading the risk of your investment by investing in a range of assets. This is because your money is ‘pooled’ with that of other investors, and is invested in one or more of the above asset classes by a fund manager.
The most common types of pooled investments are open ended investment funds, investment trusts and life assurance funds.
The Third Layer
The third layer is what is sometimes known as a tax wrapper. This means that your investments are held in a ‘wrapper’ such as an investment ISA or a pension and you pay less – or no – tax. With a pension you get tax relief as well.
Investment ISAs (Individual Savings Accounts)
There are two types of ISA - cash or investment. For cash ISAs see Savings (for the short term).
You can invest in two separate ISAs in any one tax year: one cash ISA and one investment ISA. This can be with the same or different providers.
You have an overall ISA allowance of up to £10,200 in the 2010/11 tax year and up to £5,100 & of that can be saved in a cash ISA and the rest in an investment ISA. Or you can invest the whole allowance in an investment ISA, but with one provider in any one tax year.
By using an investment ISA you invest in longer-term investments such as:
- individual shares or bonds, or
- pooled investments such as open-ended investment funds, life assurance investments or investment trusts.
You can transfer money from a cash ISA to an investment ISA – but not the other way.
You do not have to pay any income tax or capital gains tax on the growth of the ISA investments. This helps anyone who pays tax.
Investing with a regulated firm
Firms advising on or selling investments must be regulated by the Financial Services Authority (FSA), or be the agent of a regulated firm. This means they have to meet certain standards. The FSA monitors the standards and can take action if we don't meet them. This also means that if you have a complaint and can't resolve it with the advising company directly, you may be able to take it to the Financial Ombudsman Service or if a firm is unable or likely to be unable to pay claims against it the Financial Services Compensation Scheme may be able to help.
How investments pay out
There are different ways you can ‘make money’ with an investment. Some investments provide:
- capital growth – the original amount you invest grows;
- income – a regular payment, for example dividends from shares;
- a combination of income and growth.
Already got investments?
If you’re saving in a pension, have a life insurance policy or are part of an employee share scheme, then you are already investing. All these invest your money in the stockmarket with a view to making it grow over a long period.
Understanding the risks
Risk and reward generally go hand in hand. The more risk you are prepared to take, the higher the potential reward. If you are not prepared to lose any of your money under any circumstances then you have to accept a lower level of return.
If you see an investment promising a high return at little or no risk, be very wary. The old saying ‘if it looks too good to be true, it probably is’ almost always applies to investments.
The important thing to remember is that, even if your investment goes down, you will have only made a loss if you cash it in at that time; it is not a real loss until you sell.
You can’t eliminate risk with investments, but you can reduce it by diversifying your investments.
What may be a small risk to one person may be huge to another. You must decide what level of risk you are personally willing to take.