UK Investment Types Explained

What are Investments?

Types of Investments

The range of investments available nowadays means that the term "investment" can mean different things to different people. Essentially all investments are based on using money to try to make more money.

Investments are therefore typically long-term commitments which involve inherent risk with regular income and/or capital growth the principle objectives. Neither is guaranteed and quite different conceptually from savings.

Savings on the other hand inherently involve the protection of your original capital from loss. Capital is deposited into a bank or building society and accrues interest which is added to the account annually. Savers can therefore expect their money to grow slowly but steadily over time. Inflation can still adversely affect the "real" values of their savings.

Stocks & Shares

Stocks and shares otherwise known as "equities", are individual units representing ownership of a company. Shares are issued by companies to raise money for business investment as an alternative to borrowing money. Shareholders actually own a stake or "share" in a company rather than simply lending it money. This means they share in its fortune whether good or bad. Shares do not have a fixed price per se but fluctuate up and down in response to any number of economic or macroeconomic factors.

These factors may or may not reflect the outlook for a company or for the market as a whole. Announcements regarding employment, manufacturing, or a potential takeover or merger bid, etc. can influence the way in which the market moves. If a company performs well, shareholders may be able to sell their shares at a profit or receive a dividend paid on each share that they hold. The reverse is also true, they may equally lose out on their investment.

REITs

A REIT, or "Real Estate Investment Trust", is a company that owns and usually manages commercial or residential property like apartments, offices, factory space, etc. on behalf of shareholders. This allows shareholders to invest in property without actually having to own the property outright. The major advantage of a REIT, in this respect, is that it is much easier to buy, or sell, shares in a REIT which are traded on major exchanges than to buy, or sell property in the traditional way.

A REIT must in order to maintain its REIT status, pay at least 90% of its taxable income annually to shareholders and invest at least 75% of it's assets in property.

Unit Trusts & OEICs

Unit trusts and OEICs ("Open Ended Investment Companies") are collective or mutual funds which allow the monies contributed by a large number of investors to be "pooled" together for investment in the stock market. The principal advantage of this approach is that it allows individual investors to gain exposure to sectors of the market that would otherwise be too risky or uneconomical. Investment in either type of fund is controlled by a professional fund manager.

The fund manager is tasked with investing in specific types of share and/or specific geographical regions to produce the best results of income, capital growth, or both. This is based on the requirements of individual shareholders. A fund manager can create additional units or shares if demand dictates.

Both types of investment can be considered "open ended" in this respect. The difference between them however is that unit trusts have an "offer" price at which they can be bought by an investor and a "bid" price at which they can be sold, whereas OEICs have a single price. The "bid-offer spread" which is typically 6-7%, should be considered an extra cost when weighing up the total cost of investment. Charges for an OEIC are deducted explicitly from the total amount invested.

Spread Betting & CFDs

Spread betting is essentially gambling. Investors speculate on two possibilities namely the upward or downward movement of an individual share, currency, or commodity, value, or a stock index – such as the FTSE 100 Index, Nikkei 225 Index, etc. – in the futures. Spread betting firms offer two prices, a price at which a security can be "bought", if an investor believes that it will increase in value in the future and a price at which it can be "sold", if the converse is true.

The difference between the two prices is known as the "spread". An investor does not actually own any assets, however he or she is purely betting on the movement of the market. If the market moves in the right direction and the investor can realise a tax-free profit – typically, say, £1 per point, above the "buy" price or below the "sell" price – but if the market moves in the wrong direction the same principle applies to losses incurred. Injudicious spread betting can therefore result in heavy losses if the market moves substantially in the wrong direction.

CFD stands for "Contract For Difference". This is an agreement between a broker or a CFD provider and a trader to exchange the difference between the opening and closing price of a share during the lifetime of a trade. Instead of explicitly buying or selling the underlying asset, an investor places a CFD trade which mirrors the movement of the underlying asset. It results in a profit or loss at the end of the trade. This "trading on margin" as it is known, for which an investor does not actually own shares, means that profits can be realised whether the market is rising or falling.

Listed CFDs

Listed CFDs work in a similar fashion to unlisted CFDs. The fact that they are listed on the London Stock Exchange means that transparency in terms of pricing is added to the flexibility of an unlisted CFD. Furthermore, listed CFDs are less risky than unlisted CFDs because of an embedded feature known as a "guaranteed stop-loss". This typically involves no extra cost to the investor but means that his or her potential losses can never be greater than their initial margin payment. This is regardless of how far and for how long, the market moves in the wrong direction.

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