Investment basics

Understanding investing:

Investment Basics


One of the most difficult decisions when investing is what you should invest in. A good investment tip is to invest in things you understand. You can invest in almost anything, but the four fundamentals are: shares, bonds, property and cash. In this section we explain a little more about each one.

1. Shares:


Shares are quite literally a share in the ownership of a company. If you buy a share in a company, you own a proportion of that company.

Depending on the class of share, that can mean you are able to vote at the annual general meeting on decisions such as the salary of the chief executive officer. It also means you get a share (or proportion) of the profit of the company. This is the dividend.

Shares are a valuable part of a portfolio because alongside the dividend, the price of a share can rise over time as well.

Of course, share prices rise and fall all the time. That is why owning individual shares can be very risky. A portfolio with a number of different shares diversifies your risk. It is possible to buy a ready-made portfolio that represents the whole stock market, or a section of it. These are called trackers.

The price of shares in larger companies are quoted on the stock exchange. In the UK the main stock exchange is called the FTSE, (more fully, the Financial Times Stock Exchange.)


2. Bonds


Bonds are a loan to a company or a government for a set amount of interest for a set amount of time.

For example Tesco might issue a bond for 10 years at 4%. This means that the buyer of £10,000 of these bonds lends Tesco £10,000 for ten years. During the ten years, Tesco will pay the investor 4% per year, or £400, and at the end of the ten years, the £10,000 will be returned to the investor

The creditworthiness of the company is important as a company that is seen as more risky (with a lower credit rating) will have to offer a higher interest rate to attract lenders.

During the ten years, the bond can be bought and sold. The price will depend on how the interest rate compares with interest rates more widely. For example if interest rates are low, the bond will be relatively attractive and the price will be higher than the £10,000 initially paid.

If the credit rating of the issuer changes, the price of the bond might also change. For governments, bonds are the main way they can raise funds without increasing taxes. The UK treasury issues bonds which are known as gilts – (they are called this as in the past the paper bonds were gilt-edged.)

As a class, bonds are usually less risky than shares. This is because interest rates do not change on a day-to-day basis, although a shift in interest rates will affect all bonds. Like shares, individual bonds are generally more risky than a portfolio of bonds, and it is possible to buy a bond fund representing a large collection of individual bonds.

Read more about bonds, what they are and how they work on the Nutmegonomics blog.

quotation marks
“An investment in knowledge pays the best interest.”

— Benjamin Franklin

3. Property


The decision about buying your own home is not only a financial one. This section will consider property as an investment.

There are two types of property for investment: residential, which is accessed by buying-to-let, and commercial property, which is most often accessed by property funds. For both, the income stream is from the rental, and it is hoped that the capital value of the property will increase as well.

Whilst on average property prices have been increasing this has not always been the case, and in some areas of the UK, and wider global markets, property prices are falling.

Property is an illiquid asset. It can take months, or even years, to find a buyer for a property and then several more months to complete on the property sale. Essentially, you have to consider your deposit and any equity you accumulate as locked in until you sell your house. Another big risk is related to interest rates. If you have a mortgage and the interest rate goes up, it might be some time before you are able to increase your rental income to cover the mortgage costs.

You also need to remember the extra costs of buying and maintaining a property, such as stamp duty, solicitors’ fees and insurance.

Read more in our paper: Should you invest in property or stocks and shares? (pdf).

4. Cash


Cash is very secure in that it is not subject to investment risk. The amount of money in your bank account will not change in response to external events, but its value will be affected by inflation.

The two risks of investing in cash are inflation and bank failure.

While very unusual, banks have failed in the past. Your cash is usually protected by the financial services compensation scheme up to a maximum of £85,000 in each bank, although you might have to wait a short time to get hold of your money.

5. How do I know what to invest in?


Just as it is safer to invest in a number of shares rather than individual shares, it is safer to invest in a collection of asset types rather than a single type. For example it is riskier to invest everything in the FTSE100, rather than having some gilts and bonds as well.

So which type of assets do you pick and how much of each?

This depends on your appetite for taking on risk. A slow and steady approach will typically have more bonds and gilts, while a more growth focussed strategy will tend to have mostly shares from a range of countries, but may have some other assets as well.

Find out more about choosing your investments in Putting it all together or see more about risk and deciding on the risk strategy.

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