Investment funds

Investment Funds, ISA's, Shares, Bonds and Savings accounts.

There are many different ways of investing cash, ranging from stuffing the money under your mattress (hardly 'investing' however), investing in stocks or shares, or even investing in things like property, antiques, or fine wines. This article is primarily concerned with investing in the more 'standard' investment vehicles, namely stocks, shares, bonds, gilts, and other cash funds.

Feel free to read the opinions expressed in these pages, but do remember that this commentary does not represent any financial advice; it is merely the opinion of the author, which may be completely wrong. Do not forget that the value of your investments may go down as well as up.

There are many ways of investing in stocks, shares, bonds, or gilts, you can choose your own portfolio by purchasing all of the mentioned items on the open market on a individual basis, or you can choose to invests with a financial institute who offer 'investments funds' that are tailored to your needs.

Types of investment fund

Stocks and share funds

Bonds and gilt funds

Specialist funds

Buying on an individual basis means that you can pick and choose your investments very carefully, and, hopefully; choose the ones that perform far better than any other. Of course, there is always the risk that you choose badly, and lose a large amount of your cash investment. Choosing this method potentially increases your rewards, but it also increases your risks. Also there is generally a set transaction fee for purchasing and selling investments of this kind, usually around 10 pounds per transaction. This means that if you are dealing with small amounts of money then you can lose a large percentage to the middleman. Buying on an individual basis requires a lot of research, a larger amount of capital, and possibly some good luck, for it to pay off well.

The alternative method is to use an investment fund which are different to shares that they try to reduce the amount of risk you take by spreading your investment across many different individual shares, bonds, or whatever the fund happens to specialize in. These funds tend not to take a set transaction fee, but instead take a small percentage of the money that you invest (usually from 0-5%) and then charge an annual fee on the amount of money invested in the fund (usually 1-2%). This means that it is possible to invest smaller amounts of money without being disadvantaged, however in the long run the return on your investment is reduced by these management fees. They may seem quite small, but over several years they can represent a large amount of money, therefore always consider the management fees when looking at investing in a particular fund.

All of these funds can be wrapped up into an equity ISA, either a maxi ISA, or a mini ISA, and so you can take advantage of the government tax break to increase your growth rates even further.

There is a huge and bewildering amount of choice of investment funds available to the consumer, with a large number of different financial institutes offering various investment funds and packages. The section below attempts to describe some of these investments funds, but is by no means an exhaustive list.

The most talked about type of investment funds are usually the stocks and shares funds, this is because it can be quite erratic at times, with incredible gains in the market as well as large crashes! However it is accepted opinion that over the long term the stock market generally performs better than most other forms of investment.

Unfortunately, however, it is not a simple matter of 'investing in the stock market', as there are huge choices to be made in the type of shares that you invest in. Correspondingly there are different types of investment funds available depending on what you what to invest in.

UK Tracker Funds (FTSE etc)

These investment funds attempt to follow the main market indices as closely as possible. You can choose to follow the FTSE 100, the FTSE all share index, the FTSE tech index or any other major stock market index, they will also invest in 'foreign markets' (see below). These funds generally have very low management charges as they simply follow what the rest of the market is doing (so can be run by computer), however there no chance of doing better than the index that you have decided to track. If you are new to investing in shares then these funds are often attractive, as although you can't do better than the market, you also can't do much worse!

UK Investment / Growth Funds

These investment funds attempt to pick and choose their shares, based on what the manager thinks is going to produce the best performance in terms of increasing your capital. Usually these funds have set aims, such as only investing in small companies, or investing in technology, health, or 'under valued companies', the list is endless. These funds are more suitable for people who have read a bit about markets and the economy, and are willing to take a guess on where the largest areas of growth are.

Investing UK Income Funds

Income funds focus mainly on providing a source of income from the dividends that shares pay out. They usually invest in the larger 'blue-chip' type companies, or other companies that traditionally pay out large dividends to the share-holders. They can also comprise of 'mixed' funds, that as well as investing in shares, also invest in different types of bonds. See 'Bonds and Gilts' for more details.

Investing in Foreign Stock Markets

Some funds specialize in investing in various regions or countries around the world, and these funds typically come in the same 'flavours' as described above, the only difference being that the shares are invested abroad. These funds can produce better gains than in the UK if a country or region is chosen that has a particularly large growth rate, and the 'emerging markets' (places like Brazil and China) can give very good returns. Some of the funds even choose to invest on a global scale and the fund managers themselves decide where the growth 'hotspots' are. However global instability, political decisions, and even the exchange rates can also affect these funds badly, so there is more risk attached to these investment funds. Argentina is a good example of how greatly your fortunes could vary when invested in one of these funds. A few years ago the economic crisis in Argentina would have all but wiped out your investment. More recently the Argentine economy has recovered admirably and a lot of money could have been made on their stock market.

Bonds and gilts are generally less talked about than stocks and shares, yet they can provide high levels of cash growth, as well as offering more security than shares. Over the long term they generally do not yield as much money as shares do, but they also do not suffer from the large swings in the market, and so offer a safer, more reliable investment.

Bonds a way of lending money to a private or public corporation, in return for a set rate of interest on that loan. Whether it is a government, or a corporation, the essential idea is that you purchase 'bonds' off of the issuer, which promises to return your money on a specific date, and in the mean time pay you a set level of interest. There are many different types of bond that are issued, and they are usually rated on a sliding scale from AAA downwards. AAA bonds are issued by very financially secure institutes such as big blue chip companies, or governments. They have a very low chance of defaulting on the loan (and you losing your money), but correspondingly they pay low levels of interest. At the other end of the scale there are 'junk' bonds, that pay very high levels of interest, but are issued by much higher risk companies, such as small businesses, start ups, or even medium to large companies that are re organising their finances. Obviously these types of companies have a much larger risk of going bankrupt, and hence there is a larger risk of losing money when investing in them. By investing in a bond and gilt fund, you buy into many different government gilts and corporate bonds, and this helps dilute the effect of any companies (or even governments- it has happened!) going bankrupt.

There are different funds available depending on what type of bonds you want to invest in, and all of them have slightly different investment strategies. There are three broad categories of funds, and these are described briefly below:

Government Bond and Gilt Funds

These are the lowest risk bonds, with money invested in governments, and other very secure financial institutes. The interest rate paid out is usually quite small, however there is little risk to your capital. The funds tend to do badly when interest rates are rising, as the interest rate on the bonds becomes less competative compared to high street savings accounts. On the flip side they tend to do very well when interest rates are falling. In either case the rises or falls are generally much less than with the stock market

Corporate Bond Investment Funds

These funds invest in good quality corporations where there is little chance of bankruptcy. They offer slightly more attractive rates than the government bonds, but there is also a slightly great risk to your initial investment.

High Income Investment Bonds

These invest in bonds that pay a higher rate of interest, and often have very attractive looking yield rates (the average interest rate of all the bonds held). However to get the high interest rate they have to invest in some risky companies, some of which do go bankrupt. This effectively reduces your rate of return on your investment, and the degree to which it happens will depend entirely on the success the fund manager has in choosing the right bonds to buy. These bonds are less sensitive to changes in the base rate of interest, as they always tend to significantly higher rates of interest than high street savings acocunts. They are more dependant on the default rate (which is the number of companies going bankrupt) which depends more on the state of the economy as a whole.

There are also groups of investment that do not really fall into the two main types above (shares or bonds). These are funds that invest in very specialised areas and so their growth rates generally do not follow the majority of the market forces. The list of specialist funds is endless, but examples of these would be investing in gold, in property funds, in ethical companies, 'unethical' companies (oil, arms, tobacco), venture capitalist funds, split caps, and zeros. Three of these, gold, property, and zeros, are discussed below:

Gold and Precious Metal Investment Funds

Gold and precious metal funds invest in shares in gold mines, other precious metal mines, diamond mines, and various other valuable ore companies. These shares tend to move separately to the main share market due to the unique commodities that they are invested in. When the financial markets look bad, people tend to get worried about holding onto cash investments such as dollar notes, or government bonds, and so want to move to something more 'real' like gold and diamonds which is perceived to be more trustworthy (Diamonds are, after all, forever). Correspondingly the share prices in these sorts of companies go up or down depending on the consumer demand for the precious metal/ore, usually by a greater percentage than what ever they are selling. These sorts of funds are therefore very useful for protecting yourself against huge stock market loses. If the stock market crashes, gold and other precious metals will become very, very popular and valuable as people rush to buy them, and at least some of your stock market loss will be offset by your gains in the gold and precious metal area.

Property Investment Funds

Property funds invest my buying property, and then letting out the property to commercial and private entities. These property funds do not generally follow the overall housing market in the UK, as they do not buy and sell residential homes. However they do move somewhat independently to the stock market. There is, however, some overlap, as generally if the stock market is doing well, lots of companies are opening new business, expanding their premises etc, and so need to rent more office space. Likewise if the stock market is doing badly then companies tend to be shrinking their office space and downsizing, so the property funds will suffer as well.

Zeros and Preference Investment Trusts

Instead of borrowing from banks, companies can issued zero dividend preference shares ("zeros"). These offer investors no dividend (hence the term zeros) but do promise a fixed level of capital growth as long as the company performs as expected. They used to be particularly attractive because they were regarded as the safest sort of share that could be purchased - nearly as safe as bonds but offering a higher rate of growth.

The only condition was that the trust's investments achieved a set return every year - known as the "hurdle rate". Often this is as low as 2%, and in some cases the trusts could be negative and the zeros would still pay out. However, the stock market's slump of 2001-2002 meant that a lot of these trusts did not meet their 'hurdle' rate, and so the zero's did not; or could not pay out. This led to a large loss of confidence in the trust funds, a heavy sell off and a large slump in the price of zeros. Given the recent return of stock market growth it could be that these zero preference trusts are now significantly under valued, and could offer a good deal to any bargain hunter, as long as the risks are born in mind.

If all this talk of risks, and growth level, share prices, and market forces is too much for you, then there is always the safe bet of normal cash savings accounts, or cash ISA's. These offer a fixed rate of interest, at no risk to your initial investment (bar the UK government going bankrupt).

Cash Mini ISA

The most tax efficient savings account is often a cash ISA, these usually offer you a high rate of interest, and also you do not pay any tax on any income you earn. Most banks and building societies offer cash min-ISA's where you can invest a maximum of 3000pounds in one tax year. It is worth shopping around for a cash ISA that offers the highest rate of interest, but also don't forget to look at other terms and conditions such as any penalties for cashing in your Isa at short notice.

Cash Savings account

Although interests rates are at a historic low, it is still better to keep your money in a savings account rather than stuffed under your mattress. Again all banks and building societies offer some sort of savings account. The higher paying ones often insist that you keep your money locked away for a certain number of years at a fixed interest rate. This means you could lose out if the Bank of England raises the base rate of interest (which seems likely in the current economic climate), but that's the chance you have to take. Often internet only accounts offer a good rate of interest, either from introductory offers, or just because the running costs of the account are generally lower for the provider.

by Alastair taylor

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