Deciding how you feel about risk is a key step before committing hard- earned savings to any investment product. One of the lowest risk investments you can make is putting your money into a building society deposit account or National Savings products. But does it pay to do so?
Your return, after tax, on pounds 1,000 over the last 10 years would have pounds 1,802.04 in an average building society account, according to the Building Societies Association. If you had been more daring and bought stocks, you could have made far more. If it had mirrored the FTSE-100 index of leading shares, the same investment would now be worth pounds 3,245, not including tax or dividends.
Between shares and building society deposits on the risk spectrum lies a wide range of investment vehicles. Government bonds or Gilts give you a fixed return and safeguard your capital, while some life insurance company products such as endowment policies and with-profit bonds keep your capital safe, but your return is subject to market conditions. With guaranteed equity products, such as protected unit trusts, you have no assurances about the level your income will be but most of your capital is safe.
Investing in shares, or equities, is risky compared to keeping your money in a deposit account, because share values fluctuate from day to day according to worldwide market conditions. Anything from an oil discovery in Asia to higher German unemployment can affect the value of UK stocks.
Putting your money in the shares of just one company can be very risky indeed. After all, the firm could go bust at any time and leave you with nothing. But you can spread your risk with collective stock market investments, such as unit trusts, investment trusts or pension funds. These will allow you to own part of a fund which in turn holds shares in perhaps a hundred different companies. Risk levels vary between funds. Your capital is safer in a fund which only holds shares of major UK companies than in one investing in small eastern European companies.
"A key message is equities are good in the long-term, but people are very wary of equities because of the risk," says Jim Preston, of Wesleyan Financial Services. "The length of time you invest reduces the risk," he says.
Any stock market investment should be held for at least five years, experts advise. In the last 25 years, there have been no five-year periods in which the stock market has shown an overall negative return, according to figures from Principal Investment Management.
Emergency funds should not be in shares, but money you do not plan to use for at least 10 years could be. Your pension savings, unless you are close to retirement, might be invested in shares, and other long-term savings you make for retirement could be.
Roddy Kohn, of Bristol-based independent financial advisers Kohn Cougar, says he uses an investment risk scale of nought to 10. Building society accounts are at the lower end, managed funds with a mix of assets including property, cash and equities are in the middle, and funds investing in the economies of Russia and emerging markets are rated 10. He encourages younger clients, in their 30s, to be risk-rated at six or eight.
"Where you've got 10 years or more to invest, you ought to be more aggressive," he says. "The less money you have the more aggressive you have to be in getting that money to grow," he adds.
It is vital to review your investments constantly, Mr Kohn says. For instance, if regular savings into a fairly risky investment have made good gains, you could switch part of it into a lower risk fund to safeguard your gains. "You may conclude you don't need to make any changes, but you will still need to make reviews," he says.
As you approach retirement, you are more likely to have substantial financial assets. At that point most advisers would tell you to invest more cautiously, possibly using Gilts or other fixed-income securities. Any downturn in the stock market would be magnified by the size of your assets, and also there would also be less time for a temporary slump in share prices to be ironed out by a subsequent upturn. And with only a few working years left, you would be hard pushed to replace any lost savings.
Judging just how risky a specific investment might be is a tricky art, and often best left to the professionals. A good independent financial adviser can help.
The Independent has published a free guide, Making Your Investments Work for You. The guide, which covers every aspect of financial planning, including paying off a mortgage, retirement and investment is sponsored by Wesleyan Financial Services. To obtain your copy, call 0800 1379749 or fill in the coupon on this page.
Kohn Cougar: 0117 9466384; Wesleyan Financial Services: 0800 22 88 55Reuse content