By Catherine Thomas-Humphreys, The Finfluencer
There is a wide range of investments available and a collection of them would be called an investment portfolio. You want to aim for a broad range of investments within your portfolio to reduce the overall risk of each individual investment.
Often this part can feel the most confusing when beginning to invest: the language is new and there are often many words to describe similar things. So, let’s break down some of the key words to better understand what they are and then we can start to make some decisions.
Types of Asset
Investments are generally called “Financial Assets”.
Assets are split into 4 broad categories called classes.
- Equities – also known as stocks or shares
- Fixed Income – also known as debt, securities, bonds or gilts
- Real Asset – tangible physical assets like properties and commodities
Cash assets include physical money, your savings, cash ISAs, current accounts or NS&I premium bonds. There are also cash equivalents which can quickly be converted back into cash, including certificates of deposit and treasury bills.
Cash is the only asset that does not carry a “capital risk”, meaning the value of your cash won’t physically go down. However, it also won’t keep up with inflation (when goods become more expensive) as it has limited opportunity to grow.
- It is considered low risk.
- It is easily accessible (also known as liquid).
- Forms a small part of most investment portfolios.
- Little opportunity for growth.
Equities are also called stocks or shares. They are an investment in a company and, as the company makes profits, the shareholder receives part of those profits, also known as dividends.
These are a higher risk investment option as company values can fall, the company can perform poorly or it can even go bankrupt. Equities form a significant part of an investment portfolio, so the larger the proportion of equities, the higher the risk and the higher the potential reward.
They are easily bought and sold via a platform and you can access the cash from the sale within 2-3 weeks. Depending on how the share performed, the capital value at time of sale may be less than you initially invested.
- Considered higher risk.
- Easily accessible, liquid.
- Forms a significant part of an investment portfolio.
- The more equities in a portfolio, the higher the risk.
- Has more potential for growth and reward.
Government and corporate bonds are the most common types of fixed-income products. They are effectively a loan to the government or a company for a fixed period of time. During the time held, you receive a fixed amount of income (or interest) in return for lending the money, and at the end of the term (maturity) they return the amount originally invested.
They help to diversify a portfolio and reduce risk.
- Considered medium risk.
- Easily accessible, liquid.
- Forms part of an investment portfolio.
- Income is known.
- Has lower potential for growth than equities.
Real assets are tangible assets which include property, commodities, and resources. They also diversify and reduce the risk of a portfolio.
- Considered medium risk.
- Not liquid and can take longer to trade.
- Forms a smaller portion of an investment portfolio.
Your investment portfolio should aim to be multi-asset in order to spread the risk of each individual investment but the proportions of each asset will dictate how low, medium or high risk the portfolio is.
For an individual investor, creating a balanced portfolio can be challenging and costly as each asset has to be bought separately and trading costs mount up. This is where funds become a useful investment strategy for investors.
A fund is like a ready-made portfolio. You can select one or add multiple funds to your portfolio for more diversification.
It is an investment that pools together money from lots of individuals. The fund manager then invests the money in a wide range of investments including Equities, Bonds and Real Assets.
They’re managed and run by a professional, so you benefit from their expertise, knowledge and research.
By investing in funds, you gain access to a wide range of investments selected by experts in different industries, locations and asset classes without the higher costs of individually selecting your own assets. You can select a fund that most closely matches your attitude to risk.
Actively Managed Funds
These funds have a Fund Manager or team of experts making decisions about the assets they are buying and selling within the fund. The fund will have a goal it intends to meet, and the team will review and amend this regularly.
The fund will state what risk level it is and what some of the underlying holdings (assets) are. Being actively managed, there is a cost to staying invested, but in return you’ve got the peace of mind that professionals are making the investment decisions on your behalf.
These typically track or mimic the performance of other assets or groups of assets (called indexes, for example the FTSE100). As they are simply following that performance, there is no active fund management, and therefore costs of these funds tend to be much lower. These funds will also share what risk level they are and may have a collection (or basket) of indexes they are tracking.
These can be a lower cost way to access the benefits of investing
Exchange Traded Funds v Index Funds
In a nutshell, these are similar but different. Both Exchange Traded Funds (ETFs) and Index funds are passive funds that track or mimic the performance of other assets. Typically, an index fund tracks a specific index, for example the FTSE 100. An index fund is mutual, which means the funds of the different shareholders are pooled together.
ETFs do a similar thing, but they are not mutual. They can track an index or they can track another fund, industry or commodity (for example, gold). A key difference is that ETFs can be bought and sold throughout the day, whereas index funds can only be bought or sold on the price set at the end of the trading day. But, for most investors, this won’t make a difference, because you will be holding your investment over a longer time.
Ready Made Portfolios
Some platforms and providers, including robo-advisors, will offer ready-made, pre-selected portfolios for you, which will likely be a collection of active and passive funds. They are often categorised by their general risk level, for example: Defensive, Balanced, Adventurous.
As a beginner investor, funds, whether active, passive or pre-selected, offer a good starting point at a lower cost point and with clear indications of risk level. You may have other preferences, such as funds in specific sectors (like technology), geographic location or investing in more ethical and sustainable companies.
You can research how funds have performed in the past, but remember past performance is no indication of what could happen in the future. If in doubt, seek financial advice or opt for a diverse fund that matches your personal preferences.
Don’t forget that the value of your investments can go down as well as up!
This content is for information purposes only, you should not construe any such information or other material as legal, tax, investment, financial or other advice.