Although the idea of investing saved capital to provide for your future financial security is gaining wider acceptance, for the would-be investor, finding the most appropriate investment can be a daunting prospect. This can be fraught with problems when seeking advice abroad or in anticipation of living abroad.
Consulting an Independent Financial Adviser (IFA) should be the first step, particularly those who are looking at the various types of collective investment vehicles available.
There are many savings products designed for specific purposes and a whole range of opportunities open to the investor wishing to generate extra income or build up a capital sum for the future. Additionally, the investor can address the need to provide for dependants in the event of an unexpected loss of earnings through illness for example.
All the forms of investment open to investors can, broadly speaking, be split into two main categories – direct investments, such as stocks & shares, or collective investment schemes where clients pool capital with others seeking the same goals.
For investors, this generally means shares, bonds or gilts. Although the spread of share ownership has widened considerably in Europe and with it public awareness of what share ownership means, it is worth highlighting the basic principles.
The price of a company’s shares is best described as determined by the value of its assets and its potential to generate further revenue. If shareholders begin to see the estimates of future revenue as unduly optimistic, or if the value of the company’s assets declines, they are likely to sell their shares and this may cause the share price to fall. If the reverse happens, demand from buyers will increase – thus pushing the share price up – and any portfolio holding reflects these changes.
The trade in stocks and shares, facilitated by market makers whose role is to quote both a buying and selling price for listed stocks and shares, is known collectively as the stockmarket. We see the share prices obtained on the stockmarkets of the world as the “FTSE 100”, or the “Dow Jones Industrial Average” – and there are many such indices.
Public Limited Companies (PLCs) in the UK are listed on the FTSE All-Share index, the 100 largest by capitalisation listed on the aforementioned FTSE 100.
Companies wishing to issue shares but lacking financial muscle or new start-up companies, may opt for the Alternative Investment Market (AIM), which means that, in most cases, companies listed on
AIM carry higher risk than those listed on the main stockmarket because they face higher business risks as they attempt to grow and attract investors. For the individual investor, the drawback to investing in AIM stocks is their lack of liquidity. Market makers will constantly quote buy and sell prices for FTSE stocks, but as trading volumes on AIM are much lower, transactions are conducted in a specialist manner and shares are not so readily valued.
The second principle form of direct investment is Bonds and Gilts. Bonds are basically debt. In buying a bond, the investor is effectively lending money to the bond’s issuer. The investor knows in advance what sort of return they will get on their investment and bonds are generally regarded as a much lower risk category of investment than shares.
Gilts are bonds issued by the UK government – the name derives from the term “gilt-edged stock” – so by buying gilts the investor is lending money to the UK government. As the UK is regarded as a safe bet to honour its commitment to buyers of its government stock, gilts are in turn regarded as one of the safest forms of investment. The issuer – in this case the government – is guaranteeing to repay your capital at the end of the bond’s term, (if there is a redemption date) and you also get a guaranteed coupon (return) throughout its life.
A bond with a face value of £100 will also pay a pre-set figure in interest every year to the holder – the coupon rate. When the rate is set it must be competitive with current interest rate levels but these may change, thereby rendering the return on your bond relatively less attractive than cash deposits. So bonds are traded in the market to reflect this. For example, a bond may be issued at a time when 6 per cent is an attractive interest rate return and as a result your £100 bond may pay a coupon rate of 6 per cent. So you have paid £100 to get £6 per year plus your original investment back at the end of the bond’s term.
But if interest rates jump to 9 per cent your coupon rate starts to look a bit weak. You therefore sell your bond in the market, but no-one will pay £100 to get only £6 a year so you have to sell at a lower figure that builds in the difference in rates.
Of course you can take comfort from the knowledge that you will get your capital back at the redemption date, in this case from the UK Treasury.
Corporate bonds work in a way that is broadly similar to government bonds – they are issued by companies as a way of raising money from investors. Again, they pay a coupon rate coupled to a pledge to repay the capital at the maturity date. Like gilts, they can be traded on the market if investors want their capital back before the maturity date.
