Investing to secure a healthy financial future can be a daunting challenge – the old adage that the value of investments can move down as well as up remains as true now as it ever did.
What investing means
Investing is when you put your money to work to help you meet your long-term financial needs. When you invest, you take more risk with your money than you do with a high street savings account, but for that risk you hope to have a greater chance of a higher long-term return.
The value of £10,000 invested over the last 20 years.
There are many different types of investments and each has its pros and cons, but while investing can potentially help you grow your money, it can also result in you losing some or all of it. The chart shows the returns an investor could expect to receive having invested £10,000 over the last 20 years in various different investment types.
Source: Thomson Datastream and Threadneedle as at 30.09.2013. Cash represented by Three Month LIBOR rate. UK shares represented by FTSE All Share Index, capital return only. UK shares with dividend income reinvested represented by FTSE All Share Index, with dividends reinvested. High yielding UK shares with dividend income reinvested represented by FTSE 350 Higher Yield Index, with dividends reinvested. £ Bond (Non Gilts) represented by IBOXX £ Non Gilts All Maturities. Property is represented by Investment Property Databank (IPD). For illustration purposes only.
The returns from each type of investment go through peaks and troughs over the years. The chart illustrates that choosing the right asset class, depending on your investment goals and timeframes is critical. The chart uses market indices so does not necessarily reflect what an investor would have received by investing in a collective fund. The figures represent the actual returns from each index and do not include any charges, fees or taxation levies, that an investor would expect to incur. It is not possible to invest directly in these indices. There are different risk factors involved when investing in equities compared with cash deposits and investors are reminded that the value of investments and any income from them can go down as well as up. Past performance is not a guide to future returns.
Should you invest?
Before you invest you need to ask yourself whether it’s the right time. Generally, people are in a better position to invest if they have paid off debt, have adequate pension provisions, and have already accumulated enough cash in savings to cover any short-term expenses or financial goals, such as car repairs, holidays, home maintenance etc.
If you have all that covered, you are likely to be in a better position to invest for the longer term and assess your attitude to risk. In order to get a better return, an investor must take on more risk, which usually means investing in something riskier than a bank or building society savings account. Taking greater risk with your savings can potentially help you to grow your money faster over the long term, but there is a danger you could lose some or all of your cash.
To help reduce the risk, a sensible investor usually constructs a diversified portfolio that is spread among a number of different types of investment (also known as asset classes). Asset allocation – the practice of dividing your investment portfolio among different assets such as cash, equities, bonds, property and commodities – is the key to aiming to smooth your overall returns. The theory is that you reduce your overall risk of losing money because each asset class has a different correlation to the others; for example when shares rise, people may find bonds less attractive so the prices may often fall. At a time when the stock market begins to fall, investors may seek to invest their money in ‘real’ assets such as gold or property. By diversifying a portfolio investors will seek not to second guess these fast moving markets where one asset outperforms another and then falls back, but by smoothing overall returns with a portfolio containing a mixture of these assets.
To truly diversify investors should look to diversify within each asset class they own too. Looking at shares alone, for example, investors could spread their investments between large and small companies, between UK and overseas companies, and across sectors that are likely to perform differently at different times such as the retail sector versus pharmaceuticals.
Understanding your own attitude to risk will help you pick investments that deliver the return you expect. Think about your investment objectives and timeframe – the more time you have, the more risk you may be able to take. Consider your risk appetite: higher returns often mean higher volatility and higher risk, but if you can’t stomach losing money then you shouldn’t look to take on too much risk.
Types of investment
Investors can choose to invest in anything from savings accounts and property, to the stock market and fine wine. Only by learning about each can you make an informed decision as to which asset you feel most comfortable investing in.
Instead of buying assets – such as equities – directly, investors can pool their cash with others by investing in a collective investment, such as a fund. They invest across a wide range of companies, sectors, countries and, often, other funds.
Collective funds allow investors to diversify their assets at the same time as accessing the experience of a professional fund manager. Investors can invest lump sums of as little as £1,000 or set-up regular savings plans from as little as £50 a month. Please note that these sums vary between groups – always check before investing.
Collective funds are sometimes grouped into geographical areas such as the UK, Europe, the US or Far East, and are further categorised by their investment strategy such as Growth or Income . There are thousands of funds split into many different sectors. The most common type of collective investments are collective investment schemes such as unit trusts/open ended investment companies (OEICs) and investment companies.
You must make sure you review your portfolio regularly because the right asset allocation for your needs will change over the years as your investment goals change.
For example, when you are in your twenties and starting investing for retirement you might have a high proportion of your money in equities, as you have 30+ years to ride out the peaks and troughs of the stock market. When you are retired you will concentrate on generating income from your capital and trying not to let your capital deplete too fast, so you may move more of your portfolio into bonds.
It is up to you to make sure your investments are still meeting your objectives as you move through life. But just as your goals may change, so your investments will go through periods of under and over-performance. This means you should always keep on top of your investments to ensure they are performing adequately.
Multi-manager funds / multi-asset funds
As the name suggests, Multi-manager funds invest in a number of underlying funds, which in turn invest in a range of different companies across varying sectors, regions and asset types . A Multi-manager will research these funds and select a blend of what he believes are the best funds available into one single fund.
Multi-manager funds come in two types:
Funds of funds invest in existing unit trusts, OEICs or investment trusts run by other fund managers.
Manager of managers give a selection of external managers a chunk of money to manage.
There will be a pre-set framework for the fund, which dictates how much of the portfolio should be given over to equities, fixed interest and other asset classes. The fund manager then decides which firms and managers have the best skills to run each part of the portfolio and hands out mandates telling each manager how their particular part should be run.
There are also hybrid multi-manager funds that use a mixture of both strategies.
Multi-asset funds invest across the asset classes and are categorised according to the mix of assets the manager invests in (i .e . what percentage of equities, shares, bonds and property he holds).
Charges and costs
When you buy a collective investment, there is a range of fees applicable, depending on how you invest.
For beginner investors, the thought of investments falling in value can be far more worrying than it is for experienced investors – usually because beginners have not fully analysed their attitude to risk. Learning about financial products and understanding the risk and rewards on offer can help even the most inexperienced investor to make informed investment decisions.
Initial fees: A one-off fee charged at the time you buy the fund. These have in the past been as high as 5.5% of the sum invested. A portion of this fee was typically used to pay financial adviser commission. However, advisers can no longer accept commission in this way due to legislation called the Retail Distribution Review (RDR). For this reason and also increased competition from discount brokers and fund supermarkets/platforms, initial charges have largely disappeared.
Ongoing charges figure (OCF): The OCF is an industry wide standard calculation that illustrates most fees and charges borne by a fund. This figure is used by investors as it offers a single snapshot of how much you are paying for a fund and makes it easy to see the impact of charges on returns.
The OCF is based on the last year’s expenses and may vary from year to year. It includes charges such as the fund’s annual management charge, registration fee, custody fees and distribution cost but excludes the costs of buying or selling assets for the fund (unless these assets are shares of another fund).
Annual management charge (AMC): This annual fee covers the cost of fund management. The AMC tends to be around 1% – 1 .5%. Actively managed funds tend to have higher annual management fees, while tracker (passive) funds tend to have lower charges.
Performance fees: Some actively managed funds may levy a performance fee, though this is a small and decreasing number of funds.
Investors should note that these charges can vary considerably.
How to invest
There are a few different ways in which investors can buy funds: direct from the fund manager, via a fund platform, or via a financial adviser.
A fund manager will usually levy an initial charge so it makes sense to use an adviser, a broker or a fund platform which allows you to compare and purchase different investments online.
An independent financial adviser will help you choose what to invest in, and will discuss your financial goals, your attitude to risk and advise you of the most appropriate investment for your circumstances.
If you have decided what to invest in yourself and do not need advice, you can use a broker (who does not give advice – also known as an execution-only broker or a discount broker), through which you can invest in funds, investment trusts, Exchange Traded Funds (ETFs) and other assets.
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Columbia Threadneedle Investments has a comprehensive range of investment funds catering for a broad range of objectives.
Columbia Threadneedle Investments is a leading global asset management group that provides a broad range of actively managed investment strategies and solutions for individual, institutional and corporate clients around the world.