Investment

Asset Classes

Recent studies have confirmed that asset allocation is by far the greatest factor in determining the returns achieved by long-term investments. Different balances of assets are appropriate for different investment objectives and attitudes to risk.

There are four main asset classes, for conventional investments: cash, property, fixed interest and equities. Each class tends to perform differently, in different market conditions. 'Managed funds' will frequently contain a mix of asset classes, with the fund manager adjusting the balance, on an ongoing basis.

Information Sheet : An introduction to investment

Cash

This refers to money held on deposit in a bank or building society account. There is no risk to the 'nominal value' of capital (the actual number of ££), although there is a risk to the 'real value' (its purchasing power), if net returns are insufficient to keep up with inflation. It is worth remembering that the return quoted is before tax. For example, a 4% gross return will actually provide 3.2% for a basic rate taxpayer and 2.4% for a higher rate taxpayer.

Unless you have invested in a special fixed interest product or account, the level of income produced will vary as interest rates change.

Property

Some people regard their home as an investment, especially if they anticipate selling it, at some time in the future. Selling your main home has the advantage of being free of capital gains tax.

'Buy to let' residential properties have also become a popular investment, in recent years. Property offers the potential for capital growth, assuming it is to be sold at some point, and rental income. A drawback of property is its lack of 'liquidity'; it may be difficult to dispose of, for a fair market price, at the time that you want to.

Property funds invest in a range of commercial properties, such as office blocks and retail premises, where the emphasis tends to be more on rental income than capital growth. Investing in property through a fund removes the liquidity problem, for most investors.

Fixed interest

Fixed interest securities are, effectively, loans made by the investor to an establishment, such as the government, or a company. The borrower (the establishment) commits, at outset, to pay a fixed level of interest, for a fixed period, and then to repay the capital. The loans are often referred to as bonds. Gilts are bonds issued by the government, while corporate bonds refer to those issued by companies.

Generally, companies with less favourable credit ratings will need to offer higher interest rates, to compensate for the higher perceived risk that they will default on repaying the loan and the interest. There are, therefore, bonds of various risk ratings, ranging from gilts to 'high yield' bonds.

Bonds are actively traded, as their market values fluctuate, as economic conditions change. Generally, the value of an existing bond, with an established interest rate, will rise, if the market expects future interest rates to fall. The value of units in a fund that invest in bonds will therefore fluctuate, although (except for high yield bond funds), bond funds tend to be far less volatile than equity funds.

Equities

Investing in equities (shares) means buying a share in the ownership of a company. This offers the potential for capital growth (or loss), as the market value of the company changes, and income, in the form of a dividend, as the profits are distributed to shareholders.

Historically, equities have consistently outperformed the other classes, in terms of long-term (10 year +) growth. However, they are also the most volatile of the investment classes, with the greatest short-term fluctuations in capital values. Share prices, at any given time, are determined partly by the perceived value of the company and partly by the emotional reactions (which sometimes amount to over-reactions) of investors.

There is a huge range of equity funds available. It is possible to select funds that invest in particular geographical or economic sectors, or to choose funds, which achieve diversification, by investing in shares of various economies.

Information Sheet: Understanding Shares

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