THE EDUCATION SECTION Every month we look at a particular financial topic in a little more detail. This month we give you part 1 of An Introduction to Investing in Funds ____________________________ Like many things in life, investing is about balance • Investments can offer both risk and reward, and generally, the bigger the risk, the greater the potential reward. It's down to each investor to find the perfect balance for them, and this will vary depending on how much you have to invest, what stage of life you've reached and what you're trying to achieve. • For new investors, the first steps can seem complicated. There are thousands of different investment products available and often the language is unfamiliar. • That's why we've written this article - to give you a clear introduction to the most important investment principles. We'll help you to understand essential terms (you'll also find a glossary at the back) and hopefully give you a few ideas for making your money work a bit harder. So, what are the basics? Why should I invest? o Often, people find life too busy to invest properly. Some see it as complicated, time-consuming and, let's face it, a bit boring. o But your first step as an investor needn't be difficult and the financial benefits can make it worthwhile. o Many of us already hold cash savings. Keeping cash in a bank or building society can be a good idea; it's secure and, even if the bank goes bust, you're unlikely to lose your money, because of protection in place for UK savers. However, at the moment inflation is deemed to be high and interest rates are at record lows, so the value of cash savings is actually falling as each year goes by - meaning that your money cannot buy you as much this year as it could last year. o That's why you may sometimes want to consider other ways to make your money grow, especially if you don't need immediate access to it. o Investing in funds, Unit Trusts & OEICs might offer a good way to grow your money over the long term, though there are some risks you should be aware of. What sort of investor am I? o Investing means taking risks - you could get back less money than you invested. So it's important to understand how much risk you want to take. Typically, the younger you are, the more risk you might want to take, simply because you have longer to recover from any periods when your investments may have fallen in value. A retiree relying on pension income might be less willing to take risk. o We have developed a Risk Questionnaire to help you understand your own Attitude to Risk . By clicking the link you will be taken to our Risk Questionnaire, which is a series of 18 questions. Once completed, simply click the Submit button & we will get back to you within 72 hours with a complimentary 4 page report that details your Attitude to Risk & the types of investments that may be suitable for you. o Click here to go to the Risk Questionnaire. Here are a few questions to consider: o What's my objective? ▪ do I need income to supplement a pension ▪ save for my children's future ▪ or something else? o What sort of return am I looking for? o Is it more important to take an income from the money or grow my money? o How long do I want to invest for? o When will I need my money back? What are funds? A fund is a "collective investment", such as a Unit Trust, OEIC (Open Ended Investment Company) or Investment Trust. An expert fund manager will use your money, alongside that of other people, to buy a number of different assets on your behalf (we explain assets in the next section). The basket of investments chosen by the fund manager is known as a portfolio, or fund. Funds might aim to pay investors a regular income or grow the money. Some do both. Here are the differences: o Growth - this means the fund aims to increase the value of your original investment by selecting assets that the fund manager believes will increase in value. It might take more risk and aim to grow quickly, or take a more cautious approach for steady growth. The latter approach might involve, say, investing in the stocks of large, well-established companies. o Income - instead of only selecting assets that the manager thinks will increase in value, income funds aim to make regular payments to their investors by selecting assets that pay out cash. This can then be used immediately, to supplement pension earnings for example. Some funds allow you to reinvest any income you receive. This means that, as each year goes by, you could benefit from investment rewards on the original amount - because assets selected for income payments may still grow in value - and also on the reinvested amount. It's like growing a sunflower and using the seeds to plant more - the longer you do it, the bigger the crop. This can have a dramatic effect on your investment value over time. Why do people invest in funds? You will find a vast range of funds are available, investing in anything from UK Property to small companies in South America. Funds are popular investments for a number of reasons - o Expertise - you do not need to have particular knowledge or investment skill, because someone else takes care of your investment for you. o Managing risk - some funds spread your investment across a wide range of different assets, regions and sectors. This helps to reduce the risk of financial loss if any single area performs poorly. There are all kinds of individual risks that a fund manager seeks to guard against, such as foreign currency movements, the impact of political instability or individual companies going bust. o Low-cost - pooling your money with other people's means you get a more varied portfolio of investments than most people could afford alone. This is because the cost of buying and selling of different assets in a varied portfolio could be prohibitive if you try to do it on your own. o Flexible - most funds allow you to invest a lump sum, or smaller, regular payments. What are asset classes? An asset class is simply a category of investment. Here are the main ones: o Cash - relatively secure and pays regular interest. It's a low risk asset but offers low potential returns and the total amount may be falling in real terms all the time, as living costs rise. o Bonds - basically an IOU, where the investor loans money to a company or government in return for an agreed rate of interest over an agreed period of time. At the end the investors get their original sum back. This is considered a lower risk investment than equities, though higher risk than cash. o Equities - shares in a company, meaning that you own part of the company. Tends to be a higher risk and higher return asset than either cash or bonds. There are many other asset classes available, including property, commodities and specialist investments, such as hedge funds. However, these can be complex and are therefore thought to be less suitable for inexperienced investors. Why all the fuss about diversification? Diversification means making sure your investment portfolio is varied, with a good mix of assets, regions, fund managers and sectors. This goes beyond asset allocation, aiming for diversity within each asset class, as well as across your entire portfolio. There are two main benefits of a diverse portfolio. o Minimising risk - there's a concept in investing called "correlation". Simply put, it means whether different assets in your portfolio gain or lose value at the same time. Imagine you have a cupboard full of shoes. If they were all wellington boots, you would be well-equipped for wintry conditions, but less happy on the beach in summer. It's similar with investing, as a poorly diversified portfolio means when one of your assets is doing badly, so is your entire portfolio. Diversification helps to minimise this danger by reducing correlation between your assets - so if one of your assets has disappointing performance, it's possible that your other assets could balance this with good performance. o Maximising opportunity - the other benefit of diversification relates to growth. It's difficult to predict which assets, regions or sectors will perform well, so it's wise to spread your investments widely so you don't miss out. It's also true that some people might not want a diverse portfolio, deciding to concentrate on a narrow area instead. However, this is a higher risk approach and requires considerable experience and expertise. In part 2 of this article next month we will discuss - • What's the difference between active and passive investing? • What do I need to know about sectors? • Should I invest in large or small companies? • Should I invest at home or abroad? • Why would I want to invest outside of the UK? Finally, as always, do not hesitate to contact us if you would like further details or information.