Understanding investment: a guide to cash, equities and bonds

If you’re a beginner, the idea of placing your money into the stock market can be daunting. But in reality, understanding the markets and how to invest in different assets can lead to greater returns and a more sustainable investment over time when compared to keeping all of your money in cash with your bank.

There are three main asset classes – cash, equities (or stocks/shares) and bonds. There are also specialist investments, which can include property funds, currencies and commodities. These require a little more expertise before being considered for an investment portfolio. It’s important to note that all asset classes have different risk/return profiles – which means that they will have different typical levels of returns compared to different levels of risk.

Cash investments are typically bank and building society savings accounts, and are the least risky place to invest your money. Bonds – also known as fixed income – are slices of debt issued by companies or governments, and pay a fixed return plus the initial deposit over a certain period of time. Equities are traded on an exchange, such as the London Stock Exchange, which many of the big UK companies trade on.

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There are many ways to access the different asset classes, but a popular route is to invest through a unit trust (also known as an OEIC) or investment trust. These are collective investment schemes that will pool the money of many investors together to invest in a range of companies, and they can be specific to a sector, theme or country. An investment trust differs slightly from an OEIC in that it is structured as a limited company and trades on an exchange like any other public company would.

Collective investment schemes can invest either actively or passively. Passive funds are not managed by a fund manager, but simply replicate a benchmark or index, for example the FTSE 100. This means that when markets are good, the value of your fund will go up, but when markets are weak, your fund will go down. Active funds differ in that they are managed by a professional fund manager, who aims to do better than the market. The objective is that the fund will rise faster than the market and fall more slowly. The charges on active funds are higher than passive funds. You will be paying for an experienced fund manager and their team to add additional value to your investment.

When considering where to invest your money, think about what your goals are. Are you saving for a house deposit that you’ll need within five years? Or are you putting away a nest egg for retirement? The timeline will dictate how much risk you can take with your money. If you are investing over a longer time period you might want to invest in riskier assets. Over the longer time frame your investment may ride out the natural rise and fall of the markets.

You should remember that the value of investments can go down as well as up, which could mean that you end up with less than when you started. One of the key principles of good investment sense is diversification. By spreading money across a range of asset classes, you can help mitigate the effect of your investment portfolio crashing if the market falls. Historically, different asset classes behave in different ways, so when one asset class is struggling, others often remain stable – which is why investing across asset classes is so important

Some favour a ‘core and satellite’ approach, where the ‘core’ of an investment is made up of more stable market-neutral investments that tend to be less risky throughout the portfolio’s lifetime, and the ‘satellite’, which is made up of riskier, regional-specific assets that might change more frequently. Whatever you do, make sure you understand the risks and commitments before investing, and if you’re unsure, seek out the expertise of a qualified financial adviser.

As an investor you can approach the selection of stocks from many different perspectives. Are you particularly interested in a theme, or a country? Do you know more about a specific company? Top-down investment is when you take a bigger, more macro view of your investments – perhaps investing in a specific theme, such as technology or energy, or taking a geographical approach and putting money into stocks that invest in a certain country. Bottom-up investment means studying individual companies and taking a view on them. Although it is always good to remember that diversifying across a number of stocks is less risky than investing in single stock.

Whichever way you decide to approach investing, ensure you’ve done your research – spend time reading up about individual funds, investment trusts or companies you’re interested in. Remember, investments should usually be held for at least five years to ride out any bumps in the market, but make sure you take time to review your investment portfolio regularly to ensure it’s performing as you expect, and still on track to meet your goals.

For more on making sense of investment, click here.