Finance Friday: Investment risks
Differing investments have different risks. The higher the risk the bigger the return investors expect. A savings account at a bank in the UK is protected by a government guarantee up to £85,000 and so there is little risk. The returns though are often less than inflation, which is a negative return in real terms.
I have a instant access account paying 0.1% and so I am actually paying the bank to look after my money; all ten pounds of it. Government Bonds are quite safe, but the returns are poor now too. Premium bonds are safe, but the returns are a lottery. You might get rich and win the jackpot, but you might have no return at all on your investment. The prizes are the equivalent of a miserly 1.3% return. Yet 47 billions has been ‘invested’ in Premium Bonds. It is better than a lottery ticket, because you can get your capital back if your don’t win. A lottery ticket is a big risk and you lose all your capital too. You do at least have a better chance of winning a huge sum of money and you can also win the odd £25.
There are also other investments. Zopa has limited risks now, but offers a lower return. Saving with Zopa doesn’t have that government guarantee, but there is a fund to compensate lenders who acquire bad debt. I’ve been lending with Zopa for over 2 years and the return has been better than the banks despite a little bad debt.
Companies issue bonds with fixed rates of interest and these pay better interest, but they are riskier. Many of these are traded on the stock market and so access to your capital is easier, but there is significant risk.
Funds invest in a diverse range of investments that will include property, bonds and equities. These are considered safer because of the diversity. Returns are often linked to the FTSE 100. The perceived risk is much lower and so the returns are much lower.
Buying shares in companies on the stock market is riskier, but the returns can be higher. You capital is at risk however. I started with just one company and their shares are now suspended from the stock market. Before they were suspended I had lost 90% of my investment. Now I have a portfolio and my investments are more diverse, giving me a double digit return. Last year I bought Royal Mail for 330p and they are now at 609p; that’s a good return. That was an IPO, but I also bought Taylor Wimpey for a little over £1 a share and they are now at 128p. A 28% return in less than six months. A riskier company was Solo Oil, that will rise dramatically if they discover oil, but so far my shares in that company have dropped by around 30%. I could lose the whole investment, but I could also make a small fortune. My return on Taylor Wimpey more than covers the loss on Solo Oil; hence the diverse strategy works. I also invested more in Taylor Wimpey, than in Solo Oil.
Diversifying by investing in different types of investment with differing risks, helps to limit the risk while offering a good return with a little luck. Different types of companies have different risks too. Today most of my investments in shares are doing well, except for banking. Sometimes there is bad news that will affect a whole sector or even good news that will affect a whole sector.
You can start investing by simply opening a interest bearing bank account and then look at riskier investments. Zopa can be a good place to start trying to get a better than inflation return. Please comment if you have thoughts on investments or questions. You can also follow me on Twitter. What will I invest in next? Maybe a technology company or pharmaceuticals or maybe insurance. I will write about it whatever it is!