Broadly speaking, there are four different types of investments – bonds, property, shares and a catch-all known as ‘alternatives’. Within each category, there are also differences that can add to or reduce potential risks and returns.
Bonds are issued by governments and companies that want to borrow money from investors. Bonds are normally issued for a fixed term and pay a fixed rate of interest. They are also known as fixed income securities. The institution promises to repay the capital at the end of the term.
If you want your money back earlier, bonds can be sold on the stock market, but the price of the stock will depend on the level of interest rates at the time relative to the rate on the bond. You may not get all your capital back. There is also the risk that the borrower does not pay the interest or the capital back at the end of the term. Governments are usually regarded as most likely to meet their debts, but there is no guarantee. With corporate bonds issued by companies, a default could happen if the business goes bust. These bonds are graded according to the creditworthiness of the issuing company.
Bonds with terms of less than three months are known as money market securities. Money market funds (or cash funds as they are sometimes known) are generally perceived to be as safe as bank deposits but with higher yields. They are not covered by the deposit protection scheme.
Many people regard property as a safe investment because it is a tangible asset, but the price of a property is not guaranteed nor is the rental income it will produce. Although residential property prices in the UK have risen inexorably during this century, especially in London and the South East, there have been times when they have fallen such as in the early 1990s.
The prices of commercial properties, which is the type of property held in funds, were also hit badly during the global financial crisis. Rental incomes depend on demand which is affected by the state of the economy.
If you own buy-to-let property, your rental income may be affected if you have troublesome tenants or gaps between tenants. You will also have to pay for maintenance costs out of this income.
When you buy shares in a company, you become a part owner of that company. Shares can be held direct or through funds that invest in a range of companies. If a company grows and prospers and its profits increase, it will reward its shareholders through regular dividend payments. Its share price will normally rise as a result. Over the long term, shares generally have produced better returns than other types of investments. Companies that produce goods that people want to buy are able to increase their prices over time, which enables them to maintain their profits and grow their dividends. It means your investment is protected against inflation.
However, the general economic outlook will influence perceptions of how much a company can grow, and there may be specific industry factors that affect its share price. Share prices can go up and down.
These are normally investments that fall outside the categories already mentioned. They include tangible assets such as commodities and gold. They include currencies. They also include derivatives such as options to buy or sell actual investments at a certain price and at a certain time.