Investing for beginners #3 – Types of investments explained

Investment types

“The future is always coming up with surprises for us, and the best way to insulate yourself from these surprises is to diversify”

Robert J Shiller

Welcome to the third installment in a series we’re calling ‘investing for beginners’, where we will be talking about different types of investments.

If you’ve already read parts 1 and 2, you’ll be aware that this series is mainly focused on investing in the stock market. However, as we will be talking about diversification and about different assets within the stock market, we think it’s worth gaining a basic understanding of the main asset classes and investment types. Investing in the stock market isn’t for everyone and when you’re fashioning your plan to become financially free, it may well be worth looking at some of the other investment types as they might be a better fit for you. We’ll also reveal the investment types that we flat out refuse to invest in (some of which are really popular!).

Stocks, Shares and Equities.

OK, so let’s start with the one most people think of when they think of investing – stocks and shares. When people talk about stocks, shares or equities, they’re talking about the same thing. In basic terms, when you buy shares, you’re purchasing a piece of a publicly traded company for a certain amount of money, based on the valuation of that company. If that companies value increases, so does the value of your share of that company. Some companies also issue dividends to investors who own shares in their company. A dividend is a portion of the profits that company makes, so in effect there’s 2 ways a stock can pay you money – dividend and capital gains. Stocks and shares are usually traded on stock markets such as the LSE (London stock exchange) and NYSE (New York stock exchange) and are primarily bought by using a trading platform (more on that in the next article). There are 3 main types of stock that you should be aware of. We go into greater detail on these later in the series, but for now, the types you should be aware of are:

Single stocks – These are shares in individual companies. When you buy a single stock, you’re buying a part of that individual company

ETF’s – etf’s are ‘exchange traded funds’. A fund is basically a collection of different companies that follow a particular index or other group type. That fund is then traded on the stock market as its own entity. Let’s say for instance you want to invest in the FTSE 100, which is a collection of the largest 100 UK companies. Instead of investing in each one individually, you could instead invest in a single ETF that tracks the FTSE 100 for you, taking out the legwork.

ETC or Commodity ETF – an ETC is an exchange traded commodity (there is a difference between and etc and commodity ETC which we will cover later) that tracks the price of or invests in commodities such as gold, oil, bitcoin etc. Instead of buying precious metal yourself, you could instead invest in an ETC that will do that for you, right on the stock exchange.

There are also REIT’s, but we will touch on these later in the series.

CFD’s – be warned

We thought we would put this investment type in its own category because we think it’s important to know the difference between stocks and CFD’s, as some trading platforms provide CFD’s as well as shares and newcomer investors sometimes fail to tell the difference.

Some of the biggest trading platforms in the UK (like Etoro, Plus 500, CMC markets) don’t actually trade shares at all. What they actually provide is a CFD, or a ‘contract for difference’. A CFD is a contract between you and the broker, basically betting on whether a stock will rise or fall in price. You never actually own the underlying share, you’re merely making a prediction whether a stocks price will rise or fall.

There are a number of reasons why we don’t invest in CFD’s, which will be covered in another article, but the notice that these providers are required to show by law which usually go something like – “76% of retail investor accounts lose money when trading spread bets and CFD’s with this provider” is all we need to hear to steer clear.

Property / Real Estate and other tangible assets

The next obvious investment type is property and tangible assets. While some people invest in other tangible assets such as watches, cars, jewellery etc, when thinking about tangible assets, most people think about property.

There are a number of advantages to investing in property – hedging against inflation, the ability to generate a steady stream of rental income, the prospect of making big gains through renovating and so on. It can also be particularly attractive during times when mortgage rates are low (as they are right now).

There are of course disadvantages. The barrier to entry can be quite high as you will need a substantial deposit to buy an additional property, as well as enough money to coves all of the fees involved. The risks can also be high due to the sums involved, especially if you don’t know what you’re doing.

Bonds

A bond is a fixed income investment where you as an investor will receive a guaranteed amount periodically in the form of interest. Bonds represent a loan between you as an investor and the borrower. The borrower is usually a corporation or the Government. The bond will then have a maturity date where the full amount set out at the beginning will have been paid back.

Bonds are thought of as lower risk due to the guarantees provided and the type of borrower (especially in the case of government bonds) . We however don’t invest in bonds as they typically provide a much lower rate of return. For reference, due to the covid pandemic, the yield on UK government bonds is currently 0.22%! Hardly worth it.

Alternative investments

The above types of investments are some of the more well known classes. But there are some other options available:

P2P lending – p2p lending is a method of investing where your money is lent out to individuals. Most often, your investment goes to a lender that collates all of the money they receive and lend it out to people who apply. In return, the lender offers you a standard rate of return. These can be considered slightly less risky than investing in stocks yourself as your capital usually has some sort of guarantee from the lender but they also usually return less.

Robo-investing – although robo-investing is usually a form of investing in stocks and shares, the money you deposit doesn’t always get deposited in stocks alone and these platforms differ from traditional investing in some key ways. Robo-investors like nutmeg and wealthify will usually offer a few different levels of risk when you open a portfolio (like low, medium or high) and will allocate your money into these pre-made portfolios. You don’t have a great deal of control over the underlying investments that are being made. Apps like plum and moneybox take this one step further, by rounding up your regular debit purchases (as an example, if you pay £3.60 for an item in a shop with your debit card, the app will round this up to £4.00 and invest the difference for you). While these types of investing apps can be good for people who really want a hands off approach, it’s not the method we feel gives us enough potential to grow wealth substantially

Real commodities – unlike exchange traded commodities, you could choose to invest in physical commodities like gold, silver and others. Whilst some people like to do this as they like the feeling of having physical assets, these come with additional considerations like storage fees (or space of you want to store yourself) and a slightly higher price point than the spot price due to the manufacturing cost. We say steer clear to keep your investing plan nice and simple.

Next Up…

Thanks for reading! Click on ‘next post’ below for the next instalment of our investing for beginners guide.

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