THE EDUCATION SECTION Every month we look at a particular financial topic in a little more detail. This month we continue with part 2 of An Introduction to Investing in Funds. Part 1 can be found by clicking here & a downloadable pdf version of both parts 1 & 2 can be found here. ____________________________ What's the difference between active and passive investing? There are two main approaches to investing, both with advantages and disadvantages. o Passive investing - this means investing in funds that are purposefully designed to track the performance of an investment market, so there is very little human input. It's like driving on a motorway but without the option of changing lanes - depending on how clear the traffic is, you'll move quickly or slowly. In the same way, passive funds go up or down with the market. There are many passive funds available & through them you can track most investment markets, like property, gold or an index like the FTSE 100, which represents the 100 largest Companies traded on the London Stock Exchange. + Tend to be lower cost due to lack of expert input Returns will be broadly in line with the market Solid investment when markets are rising - Your investment will fall in value if markets go down Unlikely to outperform the market No flexibility to adapt to new opportunities o Active investing - an active investment approach often means that the fund manager is using his or her expertise to seek stronger returns than the investment market. So, in contrast to the passive car, it has the freedom to change lanes and find a different route. This means an active fund has the potential to perform better than the market, or "outperform". However, it could also provide less growth than the market. An active manager can also try to manage risk, by keeping an eye on markets, economies and global trends, and selling assets that look likely to lose value. The success of this depends on the skill of the manager as well as careful research and analysis. + Flexibility to adapt to changing markets Potential to outperform the market, but this is not guaranteed May be able to switch into safer assets in poor economic conditions - Cost more, due to expert input Risk of underperforming the market Dependent on the skill of the manager What do I need to know about sectors? In investment terms, a sector is another word for an industrial area of the economy in which companies provide a similar product or service. There are numerous sectors, though they can be broadly grouped in the following way: Defensive sectors (tend to be safer in a falling market) - o Consumer goods o Utilities o Health Care Growth sectors (tend to do well in rising markets) - o Technology o Financials o Energy o Materials o Industrials Should I invest in large or small companies? There are also investment sectors that group companies by size. For example, if you invest in the FTSE 100, you're investing in the hundred largest companies in the UK. In contrast, the FTSE SmallCap Index covers smaller UK companies that are traded on the stock market. Here are some of the differences: Small companies + Can be quick to respond to changes and new opportunities Can grow rapidly - May struggle to weather bad economic conditions Large companies + Big enough to survive during tough economic times Size means lower risk for investors Relatively stable profits mean some pay regular dividends to shareholders - Can be slow to respond to changes and new opportunities Should I invest at home or abroad? Many investors in the UK focus on British companies, bonds and sterling cash savings. Partly, this is because the UK provides a mature economy where major social, economic or environmental upheaval is unlikely. It's also a well-regulated market with numerous laws to protect you from illegal or unfair practices. However, you may want to look farther afield to benefit from diversification and greater opportunities. Why would I want to invest outside of the UK? You can diversify outside the UK by investing in other Western economies, such as the USA, Japan and Europe. Like the UK, these are mature markets where investment practices will be tightly controlled. Or, you could invest in emerging economies, like China, India and Russia, which are experiencing rapid economic growth and therefore offer exciting investment potential, although greater volatility. However, you should be aware that many overseas investments operate in foreign currencies, and therefore changes in exchange rates can affect your investments positively or negatively. Developed Markets + Mature economies, so relatively stable Strong Regulation Consumer Protection - May not offer the strongest growth Exchange rate risk outside of the UK Emerging Markets + Have the potential to become leading economies in the future Experiencing rapid growth - Immature economies, so may be less stable Poorer regulation Less consumer protection Exchange rate risk Where do I go from here? Hopefully, we've helped you on the first steps towards making the most out of investing - it's all about taking a balanced view of assets, regions, sectors, and of course risk and reward. So why not take the next step & contact us for full & independent advice on how to make your money work harder for you! Finally, as always, do not hesitate to contact us if you would like further details or information. ____________________________ Glossary of terms Active investing - investing where the returns depend on the skill of an expert Annual management charge (AMC) - the yearly fee a fund manager charges investors for its expertise Asset allocation - deciding how much to invest in different asset classes (bonds, equities, cash, etc) Benchmark - a standard against which the performance of a fund is measured, e.g. an index such as the FTSE 100 Index Bond - a loan from an investor to a company or government in return for regular interest payments, over a pre- agreed period of time Correlation - the degree to which assets within a portfolio rise or fall in value at the same time Derivatives - a financial contract, the value of which is determined by the price of something else (such as a share or financial index or an interest rate) Diversification - spreading investment across a number of different assets, regions or sectors Dividend - a payment made by a Company to its shareholders Equity - a share of ownership in a Company Growth - the increase in value of your investment Income - the payments you receive from your investment Initial charge - a one-off fee investors pay to join a fund Passive investing - investing where the returns depend on tracking market movements Return - the amount you gain in terms of income and growth in your investment Risk - the potential for losing value in your investment Important Information This document is issued by The Financial Group, which is authorised and regulated by the Financial Conduct Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS and is registered in England and Wales, Company Registration No.5838482. This document contains The Financial Group's views and as such this document is deemed to be impartial research. We do not undertake to advise you as to any change in our views. Opinions expressed are as at the date of issue (May/June 2013), but may be subject to change. The material contained in this presentation is for information only and does not constitute investment advice or recommendation to any reader of this material to buy or sell investments. Investment Risks Funds that invest in a smaller number of stocks can carry more risk than funds spread across a larger number of companies. Investments in smaller companies can be less liquid than investments in larger companies and price swings may therefore be greater than in large company funds. Where a fund holds investments denominated in currencies other than sterling, investors should note that exchange rates may cause the value of these investments, and the income from them, to rise and fall. Potential investors in emerging markets should be aware that emerging market investments can involve a higher degree of risk. Less developed markets are generally less well regulated than the UK and do not have the strict standards of accounting and transparency present in developed markets. Some of these markets may have relatively unstable governments, economies based on only a few industries and securities markets that trade only a limited number of securities. As a consequence, both the value of investments made and the case of which the underlying securities can be bought and sold may be adversely effected. Some funds may use derivatives for investment purposes. These instruments can be more volatile than investments in equities or bonds.