Are you waking up with a sore back these mornings, due to that growing wad of banknotes under the mattress? It is worthwhile looking at the various savings and investment products now available, in order to make your money work a little harder for you. Do I choose savings, stocks and shares, or bonds?
Before doing so, however, you must identify your ‘risk profile’ as an investor. How much risk do you feel comfortable with? Certain products offer more promising returns than others, but the risk is higher as well, and many investment products carry a warning that ‘the value of investments can go down as well as up’. This means that, in a worst case scenario, you could be left with less than you put in.
There are five key questions you should ask yourself to identify your risk profile:
1. Am I comfortable with the value of my investments rising or falling by 25% or more in any given year?
2. If my investment fell significantly in value, would I see this as an opportunity to buy more at cheaper prices?
3. Would I prefer an investment which could not fall in value at all?
4. Do I prefer the security of bank accounts to more risky stock market-related investments?
5. Am I happy for the value of my investments to rise and fall quite rapidly in the short term?
Furthermore, your choice of investment might well evolve as you move through the various stages of your ‘financial life cycle’. For example, as you approach retirement you may wish to reduce the level of risk, moving your funds to more conservative products as any losses at this stage might be difficult to replace.
There are three principal routes to go when looking for a home for your cash: savings, stocks and shares, and bonds.
Savings accounts at the bank or building society are the standard option, with returns typically around 4% p.a. and relatively little risk. You can also avail of the cash Individual Savings Account (ISA) which enables you to place your money (up to a limit in 2009 of £3,500) in an account where it attracts interest tax-free. There are various ISAs available at varying rates of interest, which makes it sensible to take financial advice.
The next option is stocks and shares. Investment values rising and falling in cycles is a normal part of stock market activity, and can easily panic a novice investor. However, it must be borne in mind that, despite these cyclical fluctuations, what goes down generally comes back up, if you have the patience and flexibility to wait. Stock market investments tend to do better than cash over ten to fifteen years.
Share investments are more adventurous, and less predictable, than savings accounts. Your money buys shares in companies on the stock exchange and your investment value changes as the value of those shares rises or falls. While it is possible to invest directly in a large company like, for instance, BP, you would be ‘putting all your eggs in one basket’ and you would be at the mercy of the fortunes of the oil and gas industry for the term of your investment.
A more sensible option which allows you to spread your risk over many companies and industries is to invest through an equity fund. Here, together with many other investors, you pay an annual fee to a professional fund manager who invests the cash in a diverse range of companies on your behalf. Best advice is to use shares as a longer-term investment. They are a great way of saving for a pension in 25 years’ time, but not for a holiday or a purchase you are planning for next year.
The third option are bond products, which have been described as a hybrid between an investment and a savings account. Bonds still place your cash in the stock market, but also pay out fixed interest, like a savings account. A bond is a piece of paper issued by the government or by a private company, which comes with a promise to pay you back with interest at the end of an agreed investment term. However, bonds can be traded, and you are free to sell your bond at any time.
