The most common investment options available to the novice investor are:

• Cash Accounts
• Fixed Term Accounts
• Government and Corporate Bonds
• Investment Schemes
• Mutual Funds
• Stocks and Shares
• Exchange Traded Funds
• Derivatives

The rate of return and risk of each investment will vary, but in general, those with higher rates of return have higher risk.

Cash Accounts

Banks and building societies will pay interest on money held in current accounts and easy access savings accounts. The rate of return on these accounts is miserably low, but bank deposits are guaranteed by the government so there is no risk of losing your capital.

Fixed Term Accounts

Fixed term accounts offered by banks and other financial institutions will pay a slightly higher rate of return in exchange for tying up your money for a number of years. Balances held in these accounts will also be guaranteed by the government.

Bonds

Government bonds and corporate bonds are redeemable at a fixed, future  date and pay a fixed rate of interest until that date. Bonds may be traded through a stock broker.

There is a significant difference between capital invested in a bond and capital invested in a deposit or fixed term account. For every dollar invested in a deposit account you are guaranteed to receive a dollar back, plus any interest that you have earned. But for a bond this may not be the case.

A bond that was originally issued at a price of $1 may be traded on the market today for more or less than its face value. As the redemption date approaches the market value will move towards the face value. So unless you buy a bond when it is first offered and hold it until redemption, the effective rate of return may be more or less than the quoted rate and you may also make a capital gain or loss on the transaction.

Government bonds are guaranteed by the issuing country, and will trade at an interest rate that reflects the stability of that country. United States Treasury bonds will trade at far lower interest rates than those for a small country in South America or an island in the Pacific. If the issuing country defaults on its debts, then the holders are liable to lose all of their investment.

Corporate bonds are similar to government bonds, except that in this case the bonds are guaranteed by the issuing corporation. Companies are far more likely to fail than countries, so the rate of interest paid on corporate bonds is higher than that paid on sovereign debt. High quality companies (‘blue chips’) can get away with paying lower interest rates than those issued by firms with low credit ratings. Bonds issued by companies having low ratings are often referred to as ‘junk bonds’.

If a company fails, its debts are settled in order of priority. Bond holders have higher priority than share holders, so corporate bonds are regarded as a lower risk investment than shares in a company.

Investment Funds

Various types of savings and investment funds exist around the world (they may be referred to as  investment plans, investment pools, collective investment vehicles, collective investment schemes, managed funds, funds, or any similar name). They are offered by different types of organizations including banks, insurance companies or specialist investment companies such as hedge funds. The provider will invest the money in the stock market (or sometimes in other asset classes) on your behalf and charge a management fee for doing so. The investment fund may be a stand alone product, or it may be used in order to support a tax efficient savings vehicle such as a pension plan. The returns on an investment fund depend on the skills of the organization running the fund. Charges for these funds can be quite high and that can considerably reduce returns. Returns are variable and the total returns may be less than the amount contributed.

Mutual Funds

Mutual funds aim to provide a simple, efficient way to access a diverse range of investments. Mutual funds will invest around a theme – for example, large European companies. The investments will be managed and selected by a fund manager. Mutual Funds deduct a percentage to cover the cost of administering the fund. Mutual Funds may be bought and sold through a stockbroker. Returns are variable and the total returns may be less than the amount contributed.

Stocks and Shares

The ownership of a company is divided into shares. Collectively, the shares in the company are known as the company’s stock. When you buy shares in a company you become a part owner of the company. Shares may be bought and sold through a stockbroker. The value of a company’s shares will vary. Some companies pay dividends which may be paid quarterly, half-yearly, or annually. Stocks and shares are regarded as a high risk investment.

Exchange Traded Funds

Exchange Traded Funds (ETFs) are similar to mutual funds, but they are not managed by an active fund manager. Instead they are constructed to buy and sell investments automatically by following a fixed formula – often an existing stock market index. This results in lower charges than for mutual funds. ETFs can be bought and sold through a stockbroker. The value of ETFs will vary in step with the value of the underlying shares. Like all investments in stocks, ETFs are risky, but they are less volatile than investments in individual companies.

Derivatives

Derivatives are high risk financial instruments designed for experienced investors. They include futures, options, spread bets and contracts for difference. Used carefully, derivatives can contribute meaningfully to an investment portfolio with limited risk. Used improperly they can quickly lead to financial armageddon.

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