Which financial vehicles are the best investment is an important question for those who wish to protect their capital. Deciding which are the best investment vehicles to use for your money depends upon a number of factors. These include the amount that you have available to invest, the length of time you can be without this money for, the level of risk that is acceptable and, perhaps most importantly, your knowledge of the financial markets.
Investments, as with every other aspect of life, work best if you understand what you are doing. If you have never been in the position of having spare funds to invest before, or if this is your first time, you need to learn as much as you can about how investment vehicles work. The most important factor to remember is that, with a number of investment vehicles, the value of your investment can fall as well as rise, in other words you can lose money if you make the wrong decisions. Therefore, there is a significant degree of risk attached and this will vary depending upon the type of investment you make.
Step one therefore is to read as much as you can about investing and the products and vehicles available to you. There are numerous publications, journals and Internet sources that will help increase your understanding of investments and a variety of financial tools that are available to help with the decision making process, so take full advantage of these opportunities to increase your knowledge about the subject before you part with money.
Step two is to test your skills. You can do this without risking any money by setting up a dummy investment portfolio of investments, using a programme like Excel and monitoring the performance over a period. By this route you will be able to hone your skills without financial risk.
Step three is to decide how much you can afford to invest, the length of time you are prepared to be without the money and the risk element. It is vitally important never to invest more than you can afford to lose. Therefore, if the intention of the investment is for a specific purpose, for example to provide a deposit for a house or an education fund, you need to look at low risk investment vehicles. On the other hand, if the money is surplus to living requirements you can afford to take a greater degree of risk.
There are a wide range of financial vehicles available for the investor, each of which will carry varying degree of risks. In essence, these vehicles work on the basis that the element of risk will determine the potential value of the return. Low risk vehicles are therefore likely to attract the lowest level of return, profit or gain.
Cash is regarded as the lowest risk investment. Money put aside in savings accounts or other cash vehicles such as savings bonds should never reduce in terms of their face value. For example, if you invest $1,000 in a savings account now, in two years time you will still have that $1,000. The return will be the interest that cash attracts. The only downside is the potential value of that cash in terms of future purchasing power, as determined by inflation. If the interest added to the cash saved is 4% per annum then, using the same example, you would add $81.6 of interest to your savings. However, if inflation has been running at 4.5% per annum you would needed an addition $91.6 to retain the same level of purchasing power. Therfore, using this scenario you will have lost $10 dollars during the period, although your capital would have remained safe.
Bonds are considered to be the next lowest in terms of investment risk. In effect by purchasing a bond you are making a loan to the organisation named on the bond document. Bonds usually come in two forms. There are corporate bonds, where you are lending the money to a commercial organisation, and treasury bonds, where the money is being loaned to the government. The bond contract will determine the amount of the investment, the rate of return or interest and the term that the bond covers. Therefore, the intention is that you will receive a set annual income and the return of your money at the end of the term. However, there is an element of risk attached. If the organisation to which the money is loaned goes into liquidation then the capital may be lost. It follows therefore that Government bonds are likely to attract a lower element of risk than corporate bonds. As with other investments the level or return on a bond is related to the level of risk, with the higher risk attracting the greater return.
Mutual and investment funds
Mutual and investment funds are investment vehicles offered by financial institutions, which spread the risk for the investor. The fund itself will be made up of a variety of investment vehicles, such as bonds and shares and the spread of these will be controlled by the fund manager and his team. The investor purchases a share of the fund. The protection afforded by this type of investment is that whilst some of the shares held by the fund may fall in value, the likelihood is that others will rise, therefore offsetting any losses. The skill of the management team is to ensure that the gains always exceed the losses. In effect therefore, these funds are designed to minimise the risk and maximise the return for the individual investor. They therefore represent a wise choice, particular for those who have limited investment experience or need a low risk vehicle.
Stocks and Shares
The purchasing of individual stocks and shares is seen to be the investment with the greatest level of risk. However, it also has the potential for providing the greatest level of return, particularly in terms of the gain in value. To take a simple example, if you purchase 1,000 shares in a retail organisation at $1 each and they have a good year, or become the target of a takeover bid, these shares might rise significantly. If that means the share value increases to $1.50, you will have gained $500 on your investment. However, if the value of those shares drops by 50% you will have lost half of the money you invested.
The wise investor will spread the risk over a range of investment vehicles, with the intention being to minimise the risk whilst at the same time maximising the return. The chosen spread will also reflect their knowledge and the level of risk acceptable to them. For example, an investor with $10,000 may choose to spread as follows: –
40% Mutual and Investment funds
30% Stocks and shares.
The anticipation with such a spread is that the investor will increase his wealth growth in real terms.
In summary therefore, it follows that the best investment vehicles are those that fall within a number of personal criteria, which are
1 – Your knowledge of the market.
2 – The amount you can afford to risk
3 – The timescale that you can do without the money
Using these as a benchmark, the spread of investment vehicles chosen should therefore be designed to provide a “best fit” to your individual requirements.