Its-YOUR-money compares investments
One of the points we looked at on the previous page was the blurred distinction between saving and investing. I've used liquidity (how easy it is to get hold of the cash) and risk over time as the main differences but those are not clear-cut either. It is probably sensible from here on to think only of what we are trying to achieve and not worry about what we call it. When we compare investments we will include savings too, because exactly the same basic questions apply.
What investments (including savings) are best?
There isn't a simple answer to that. It all depends on your circumstances and what you want to achieve. And of course, your situation can change. An investment that is right for you now might not be right for you in ten or twenty years’ time.
The aim of this guide is to help you understand the key features of the most common forms of investment (including savings), and what you can realistically expect to achieve with them.
What do I need to know?
To compare savings and investments and decide which are right for you, you need the answers to just three basic questions:
These three questions can be summed up in three words: return, timing, and risk.
We will deal with each of them in more detail later. Meanwhile always remember there are three key questions, and if you don’t know the answers to all three, don’t part with your money.
The amount of cash you expect to receive in return for your investment is obviously important to you, and if it looks a lot you may be tempted to ignore the questions of timing and risk.
For example, if you expect to double your money you might feel relaxed about whether it happens this year or next, or even in twenty years’ time. However, doubling your money in one year gives you a rate of return of 100% per year, whilst doubling it over twenty years gives a rate of only 3.5% per year. Even putting your money in something really safe like National Savings will double your money over twenty years or so. When we talk about rate of return we simply mean how fast our money builds up in the savings account or investment.
The reason that the rates of return on National Savings look pretty tame is because they are about as safe as you can get. But if someone promises you that he or she can double your money in two or three years, you can bet there is a good chance that it won’t happen. In fact there is probably a good chance you will lose it all. There is a saying in poker that if you haven’t spotted the patsy within half an hour of joining a game then you are the patsy. The same principle applies to investment: if something looks too good to be true then it probably is and you risk being taken for a ride.
So how can I tell if it’s too good to be true?
The short answer is to compare what you are being offered against other similar investments. This is pretty easy for simple savings accounts: the rates of return offered by banks, building societies, and National Savings are published regularly in newspapers and on the internet. If the rates you are being offered are higher than average savings rates, then you can be sure that they are riskier than the average savings account.
It isn't so straightforward when you are looking at stock market investments, or property, and it’s even more difficult when you look at alternative investments such as antiques or financial derivatives. However, there is one rule of thumb that you can use, and later in this guide we will look at this question in a lot more detail. For now though, any investment that seems to offer you a rate of return in double figures (that is 10% a year or more) is pretty risky – and don’t let anyone kid you that it isn't . To obtain rates of return that are higher than a ‘natural’ rate (which we will talk about on the next page) you are effectively betting on your ability to pick the right investments or pick the right times to buy and sell. We call it speculating.
Saving, investing – and speculating!
Every type of savings and investment carries some sort of risk. Even the ultra-safe National Savings products can’t stop inflation and economic growth eating away at the spending power of our money. We look to market-based investments in both real and financial assets to provide the long-term growth that these low-risk products don’t offer. However, individual market-based investments are high-risk anyway, and even a wide spread of market-based investments are pretty high-risk in the short-term. On one hand these risks represent a danger to our wealth, but at the same time the quite large variations in market prices provide an opportunity to make money. That’s speculating – and it’s a good way of getting your fingers burnt if you don’t know what you are doing.
On the next page we will be looking at how inflation and economic growth can affect our investing.
|9 October, 2008 © 2008 K.R.Wade and Co Ltd|