Despite the number and apparent complexity of products on offer they all consist of just four basic investments, albeit in different quantities. They are cash, bonds, property and shares.
A cash investment is safe and dependable. Interest gets paid, but take off tax and then adjust for inflation and you’re usually left with next to nothing.
Bonds are essentially loans that can be bought and sold. The most common are government loans, or gilts. But you can also trade corporate bonds, which are loans to large companies. The capital value of bonds moves up and down in relation to interest rates. Over the long term, gilts and bonds should return slightly more than cash.
Many people believe that property is the best investment of all thanks to rising house prices over the last few decades. The value of your house may have leapt over the years, but don’t forget all that money you have paid out to fund the mortgage!
Just how well property has done is actually quite hard to calculate however (you need to include bills for repairs and maintenance for example). In addition, it can be awkward to buy and sell — you can’t sell little bits here and there when you need the money.
Shares, or equities, mean investing in a company like Vodafone (LSE: VOD), Unilever (LSE: ULVR) or Tesco (LSE: TSCO). You can buy shares in individual companies yourself, or you can buy a fund that invests in a broad range of companies on your behalf.
WHAT IS BEST IN THE LONG TERM ?
Numerous studies have been done about the rates of return that each of them have produced down the years. Generally speaking, assets that have demonstrated higher returns tend to be more volatile, especially when you look at short periods. And the asset that has generated the best returns over the long term is equities.
According to Credit Suisse First Boston, here are the average annual returns for the UK since 1900. These figures are adjusted for inflation, also known as the real return. This is because you want to compare like with like, i.e. spending power now versus spending power in the future.
The numbers may look small but you need to consider the power of compounding. Even a real rate of ‘just’ 5% can produce a large sum, given enough time. It also means that apparently small differences can have a significant impact on the final amount.
Let’s look at what would happen to £10,000 invested over 20 years at the above rates (i.e. still adjusting for inflation).
It must be stressed however that these returns are certainly not guaranteed. These figures are the average returns from the past 110 years.
Looking at shares, in the 1980s and 1990s, returns were a lot higher, while in the 2000s they were much lower. They could be higher, or lower, over the next 10, 20 or 30 years as well. No one knows.
Still, it is worth pointing out that these performance figures include the Great Depression that followed the 1929 crash, World War II, Black Monday in October 1987, the Asian Crisis of 1998 and the two bear markets we’ve endured since 2000. Investing in shares over the short term is very risky, but the longer youinvest for, the less risky and more profitable it should become.
Watch out for charges
Charges also play a part in your overall investment. All else being equal, the lower the charges you pay the higher you can expect your eventual return to be. As we saw in the table above, even small percentage differences can make a huge difference to the final amount.