Lesson 1

Types of Investments

When it comes to making investments, there are a number of different options available for investors.

Each of the options vary depending upon their characteristics, risk profiles and complexity.

Some investments are simply easier to understand and easier to transact, often resulting in mediocre returns for investors.

Below are the main options available for investors.

Cash

Cash is the most easily recognised ‘investment’ for inexperienced investors as most people are familiar with the process of saving money in a bank account and receiving interest payments from a bank.

In recent years, interest rates have not delivered for savers and many have complained that their savings have diminished in value. This is mostly the case because inflation has outpaced interest rates, which means that people’s savings are worth less and less over time.

Unless an individual is signed up to a ‘club’ with their bank that delivers a higher interest rate, the typical rate delivered to savers is below 1% (as of 2020).

When the inflation rate is above 1%, people that save their money in the bank lose out – in the UK, the inflation rate tends to be around 2% a year.

Saving money in a bank account is considered to be low risk, which is a key reason why the return is so low.

Bonds

A bond is basically a fixed-income investment that delivers income to an investors across a set schedule – which could be quarterly (most commonly), semi-annually or annually.

When an investors buys a bond, they are essentially giving their money to an organisation that takes the cash as a debt obligation.

In other words, the organisation has taken  your money as a debt and will therefore pay you interest on that debt.

There are two main features of a bond: the principle and the coupon.

The principle is the money that you pay for the bond, while the coupon is the interest payment that the organisation regularly pays to you.

Bonds are usually issued with a fixed timeframe and the organisation agrees to pay the principle back in full at the end of the agreed timeframe.

For example, if you buy a 5 year bond for $1000 in 2020, the organisation will pay that same $1000 back to you in 2025.

Say if the 5 year bond came with a 4% coupon that was paid quarterly, you’d receive $10 every 3 months for 5 years.

So in total, you’d get the $1000 back in 2025, along with $200 across the 5 year period.

There are two main types of bond, a corporate bond and a government bond (commonly known in the UK as a gilt bond).

Government bonds are obviously when you allow the government to borrow your money, while corporate bonds are when you allow companies to borrow your money.

Corporate bonds are considered riskier than government bonds and therefore come with a higher return, usually between 4% and 6% a year.

Gilt bonds on the other hand are more similar to the interest rate on savings, at around 1%.

The reason that corporate bonds are considered riskier is that a company is much more likely to go bust than a government.

The assumption in finance is that the government will always guarantee their debt obligations to you, which is typically true when you consider that a government can simply print money to meet their debt obligations.

Stocks

Stocks are considered to be the most risky type of investment. In simple terms, this is because you become part owner of a company when you buy stock in it.

As a shareholder, you have a claim over a certain percentage of the assets and income of a company, which will vary depending upon the performance of a firm.

If a company does not perform well, your stocks could decrease in value, potentially becoming worthless if a company goes out of business.

Meanwhile, if a company performs well and can continuously do so, the sky is the limit in terms of how valuable your stocks may become.

The typical return on a stock is hard to assess but 10% a year is often seen as a benchmark. Big returns are possible though and are often widely publicised, like when TESLA stock increased by 500% in less than a year in 2020. 

Therefore, you can see that stocks are the most attractive investment option. 

With that said, stocks are arguably the most complicated type of investment and it is often difficult for amateur investors to do well. 

Our course will talk a lot more about stocks, making it easier to make sense of and to navigate successfully.

Alternative Investments

Cash, bonds and stocks are seen as the most traditional forms of investment. However, there are other forms that make up the category known as ‘alternative investments’.

These include investments in art, wine, antiques or jewellery.

It is possible to make good money in this category but to the most part, these types of investments are not recommended and are seen as speculative.

Unless you have experience in a partiuler field or expert knowledge, it’s best to steer clear of alternative investments.

Alternative investments are often very hard to value because the price that someone is willing to pay for something is much more subjective.

For example, one person may like a painting, while many others may hate it. As a consequence, selling the item may be tough.

The key advantage that traditional investment options (cash, bonds, stocks) have is that they are very liquid, which means that they can be sold easily at almost any time.