A beginner's guide to investing

Useful tips on ways to invest your money

02 July 2012: There are many investment funds to choose from but it’s important to bear in mind that you should invest for the long term, at least five years. Please remember that the value of investments can go down as well as up and you may not get back the money originally invested.

Do I need to have a lump sum of money to start investing?

Not always. In most cases, you will have the opportunity to choose between investing regularly with a direct debit and investing a lump sum. You can also choose to do both.

What is an investment fund?

An investment fund is a pool of money from multiple investors whereby a fund manager has the ability to invest this money on the investors’ behalf. Each investment fund will have a stated objective that it aims to deliver against.

There are 1,000s of investment funds to choose from, each offering investments across a range of asset classes, with differing objectives. As well as differing asset classes, funds will have certain parameters they must stick to, for example:

• What they invest for – a fund will typically exist to either provide an income to its investors, or to grow the money they have invested.

• What they invest in – this is where a fund will tell you the assets it can invest in.

• Where they invest – funds can specify certain geographic regions that they will specialise in, whereas others may have free reign to invest across the globe.

What are asset classes?

This term is used to group together certain types of investments. The typical asset classes you will come across are:

• Cash – this is effectively money you hold with a bank or building society in a deposit savings account, for example, an instant access savings account or a fixed rate bond. Cash carries the least risk to your capital but you need to remember that inflation will impact how much your money grows in real terms.

• Government/Corporate Bonds – these bonds act as a loan to the government or a company (corporate bonds). In return for investing your money in the bond, the borrower agrees to pay interest on the money as well as to return all of the money at a specified future date.

• Commercial Property – investing in commercial property typically involves owning a property/site and leasing it to a business in return for rent. As with renting out a property, the rental income is very important but money can also be made and lost in the price of the underlying building at the point of sale.

• Equities – this is where you will invest money in a company listed on a stock market (i.e. FTSE 100) in return for a ‘share’ of their business. The price of the shares in a company will typically rise and fall over time, the idea being to buy low and sell high. Some companies pay dividends on their shares; this is where the company uses some of their profit and pays it directly to their shareholders.

• Commodities – you may know commodities as; gold, oil or copper. In essence, a commodity is a good which is purely driven by the level of supply, and the demand for the commodity. Commodities can offer the potential to grow the money you invested but they do not pay an income.  

I’ve heard about diversification before but what is it?

Many investors aim to achieve diversification and what this basically means is ‘spreading’ your investments. If you invest 100% of your money in equities and the equity markets fall in value, your money will undoubtedly fall in value. History tells us that markets move at different rates, in different directions and at different times, so by spreading your money across a number of asset classes you can help reduce the risk of being subject to one asset class’s movement.

Are investment funds all managed in the same way?

No. Most investment funds will either fall under the category of ‘active’ or ‘passive’. A small number of funds will also be classified as ‘multi-manager’. There is no clear winner or loser when looking at management style as they could all support a diversified portfolio.

We’ve included some examples below to illustrate the difference between the three categories. We’ll assume that the same investment fund invests in companies in the FTSE 100 index (the top 100 companies listed in the UK).

Active fund – a fund which will select companies from the FTSE 100 where they believe there is potential to help them achieve the fund’s objective. For example, they will identify companies that have the potential to raise their share price to help them achieve a growth objective. As such, these funds will typically aim to outperform the index through selecting companies, though there is no guarantee that they will.

Passive fund – a fund which aims to replicate the performance of the index, which in this case would be the FTSE 100. To achieve this, the fund manager will invest in the vast majority of the companies in the index on a proportionate basis to help reflect the size of each company within the index. There is no guarantee the fund will exactly mirror the index, likewise, there is no guarantee the index itself will grow all of the time.

Multi-manager fund – a fund which invests in a number of other funds. In this case, the multi-manager funds won’t invest in the companies directly but instead choose a range of actively and passively managed funds that invest in the index to help achieve its objective.