An investment is the conscious act of committing money to a particular venture with the expectation that it will obtain an additional income or profit - generating a 'return' over a period of time.
There are a variety of ways to go about making an investment, and many offer the potential of earning a greater return than can be made with a regular savings account or ISA. All investment opportunities however come with an element of risk, and in some cases individuals may not gain any returns at all, or even get any of their original investment back.
Essentially, there is no single investment that will work for everyone. Making the right investment often depends on in-depth research and the consideration of factors such as an individual's financial objectives, risk profile and personal circumstances. This can make the process of investing rather complex.
This page will explore the basics of investing, including the reasons why people choose to invest and the most common types of investments. It will also highlight important risks and factors that should be considered before investing and how a qualified accountant can help.
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Why make an investment?
Some people may be satisfied with keeping their money in a bank that pays them a good interest, and may not see the need to find other vehicles for investment. Others however will see investing their money in particular endeavours as an opportunity to grow their money significantly faster than inflation and savings accounts.
There are several reasons why people may choose to invest. Many see it as an opportunity to plan for the future, such as their retirement or for their children's education. Others invest to obtain a sense of financial security, or to secure another means of earning money that does not require working longer hours or taking on another job.
Another reason people choose to invest is simply to make their money work for them. For those who are financially secure and have savings, buying and selling assets that increase in value provides an opportunity to gain potentially higher returns and make the most of their position.
Essentially, every investor will have a unique set of personal circumstances and individual savings goals, which will collectively help to determine what investment opportunities they pursue. These will vary in type and additional elements quite considerably, so it is important for potential investors to take time to explore the investment options available to help them find the best one(s) for them.
There are numerous investment opportunities on offer and each one differs in terms of risks and probable gains. The following asset classes tend to be the most popular investment options:
Stocks and shares
A great many people will invest by purchasing shares, or 'equities', of a company through a stockbroker. When you buy a share in a company, you effectively share ownership along with all the other shareholders, and the value of your investment will grow or fall as the value of that company decreases or increases.
As a shareholder, you will benefit from a share in the profits of the company in the form of regular dividend payments. This can provide a steady income, especially if the company continues to do well. Investors may also benefit from capital growth - the profit made from selling a share for more money than it was purchased.
The risk associated with investing in shares lies in how suddenly and sharply share prices can fluctuate. Although a large profit can be made if you sell your shares when the company value is high, you could lose a lot of money if the company does not do well and the value drops. Shareholders are thought to benefit more from long-term investments, as they will be in a better position to ride out any fluctuations in the market. Another disadvantage is that dividend income from shares is liable to tax.
Bonds or gilts
A bond is a form of debt that has been issued by a company (corporate bond) or the government (gilt). Investors who purchase these are essentially loaning their money to the issuer, and in return they are paid a set rate annual interest on the loan amount. This makes bonds ideal for investors who want an additional source of income rather than long-term capital growth.
Bonds - particularly gilts - are considered low-risk investments in comparison to shares. The risk of corporate bonds however, will depend greatly on the risk profile of the company that issues them. Those with a lower credit rating tend to be viewed as high-risk investments. These will typically offer a higher rate of interest to attract bond-holders and compensate the additional risk.
Furthermore, the return from bonds is not always guaranteed. If a company collapses, bond-holders are generally paid before shareholders, but this repayment will depend on whether funds are available. Investigating the companies issuing bonds can help you to make the right investment choice.
Property investment can be a profitable venture, with the potential of high returns if the choice of location and method of investment is successful. There are two types of property investment to choose from:
1. Direct property investment
- Buy-to-let - purchasing a property with the aim of letting it. Renting out a property can provide a regular source of income, as well as long-term capital growth if the value of the property has increased by the time it is sold.
- Property development - purchasing a property with the aim to renovate it and then sell for a profit.
2. Indirect property investment
- Property fund - investing in a property fund can provide a regular income in the form of dividends or rental income, depending on the type of fund chosen. There is also the potential to secure capital growth when you sell.
There are various risks associated with property investment. Some people may need to borrow money to fund their investment and this means committing to mortgage repayments. As the cost of borrowing is likely to fluctuate during the period of property investment - which could see interest rates soar - regular rental income may not be enough to cover the repayments. Furthermore, rental income is liable to tax which can affect overall returns.
Property development risks depend on how long the renovation takes. In some cases, renovation may take longer than expected which means costs are extended and sale of the property is postponed. For those hoping to sell quickly, the process of concluding a sale can be very long-winded and complex.
Essentially, once money is tied up in property investment, it cannot be accessed at short notice. This makes property investment more suitable for those keen to take on long-term investments.
As explained above, no investment option is without a certain degree of risk. Potential investors must be fully aware that the act of investing could see them lose some or all of their money. This is because the money invested in assets and securities is not federally insured.
Whilst for many, low-risk investments may be the preferred option, the reward for taking on high-risk investments is a potentially greater investment return. High-risk investments tend to be more valuable to those who are willing to invest in the long-term and who are keen to channel their money into stocks and shares or property. The people who fall into this category of investors generally have a low-risk profile, in which they are in a financially stable position, or single with no dependents.
A parent with three children however will typically have a high-risk profile, and may benefit more from investing in bonds or banking assets such as cash ISAs and savings accounts. Savings accounts and cash ISAs are regarded as liquid assets - investments that can be quickly and inexpensively turned into funds. Another advantage is that ISAs are exempt from Income Tax and Capital Gains Tax.
Can you make safe investments?
Generally there is no such thing as safe investments, as the outcome of any investment is uncertain. There is however ways to manage investment risk - such as choosing low-risk investments and adhering to the saying: 'don't put all your eggs in one basket'.
Having a varied investment portfolio, in which several different investment opportunities are pursued, can help to disperse investment risk. This is because if one investment loses money, the returns from others can potentially balance out the loss. A varied investment portfolio will also enable investors to make the most of both long-term and short-term investments.
Again, taking care to conduct thorough research into the various investment options and their associated risks can help you to determine the best investment opportunities for you.
What to consider before investing
As well as doing your research into the different investment opportunities - using your personal circumstances, risk profile, and financial goals to help determine your investment portfolio - there are other factors that may need to be considered before investing. Some of the most recommended factors to consider are:
Do you have any debt?
It is important to get debts under control before investing because large debt repayments and high interest rates on credit cards and short-term loans will be generally higher than any potential returns. This will prevent you from reaching your financial goal.
Additionally, if an investment is unsuccessful and you end up losing money, you risk defaulting on your debt repayments. Try and pay off all your debts or at least reduce them to a level that you can comfortably manage before channelling your money into investment ventures.
Do you have cash for emergencies?
Having money to fall back on is considered crucial when investing, and investors are advised to have at least six months worth of income available in a savings account to provide suitable backup if faced with losses. The exact amount of these savings will typically depend on your personal circumstances and whether you might need the money for something else in the short term or in the case of an emergency.
Are you protected?
Before investing it is considered wise to make sure your finances are protected in case an illness prevents you from working for an extended period of time. Life insurance, critical illness insurance and income protection are key areas you may want to consider, especially if you have loved ones who rely on you financially.
Tax on investments
Most types of investments are subject to income tax, whilst any gain, or profit may be liable to Capital Gains Tax. When making investment decisions, the tax implications of each investment opportunity should be considered to help you determine what returns you are likely to make.
The investment income that is liable for tax include:
- interest from most savings
- rental income
- dividends from shares
- capital gain from the sale of shares or property.
Tax rates will differ across the various sources of investment income, and generally depend on your tax band and the specific type of investment. It is recommended that you conduct research into the specific rules for each in order to gain some idea of entitlements and exemptions.
Some investors may consciously seek out tax-free investments, such as cash ISAs, Child Trust Funds and pensions. These too come with specific rules and regulations but investors generally do not have to pay income tax or Capital Gains Tax.
How can an accountant help?
With so much to consider and so many options to choose from, investing can be very confusing and complex process - especially for first-time investors. There is however valuable investment advice and support available in the form of a qualified accountant.
An accountant specialising in investments can help you to invest your money wisely - helping you to secure viable investments that are appropriate to your personal circumstances, the amount of money you are investing and the returns you are hoping to gain. They will know where the best tax-free investments can be found and will be able to pinpoint low-risk and high-risk investments. Essentially an accountant can help to make investing a much simpler process.
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