The two types of investment you need to know about

The two most popular asset classes in which to invest are equities and bonds. Here we look at both and how they work.

What is an equity?

Equities is another term for shares in a particular company. It’s what usually comes to mind when someone talks about investing. You buy shares in a company and hope to profit from their growth.

Being a shareholder means you’ve bought a stake in a company. The aim is to earn a return in the form of capital growth, income from the payment of dividends, or a combination of both.

You can buy and sell shares in a number of different ways, such as through a stockbroker.

As an aside, dividends are sums of money paid to shareholders as a reward by a company out of its profits or reserves.

How share prices move

If the company does well, its share price will normally rise and lift the value of your investment. Conversely, if it does badly, the share price can go down.

Take the example of buying 10 shares at £5 each. You will have invested £50. If the share price rises to £6, then your stake will be worth £60.

Of course, it can also go down. If the share price drops then the value of your investment will also go down, although the loss is only on paper until you crystallise it by selling the stock.

Therefore, even though investing in shares – or equities – can be potentially rewarding, it does come with a fair degree of risk attached.

What is a bond?

The best way to think of a bond is an IOU. You are effectively loaning money to the bond issuer, which can be a company or a government.

In exchange you’ll receive a fixed rate of interest over a pre-determined period, as well as your original investment returned on a specified future date.

They are seen as less risky than equities. Therefore, holding them helps reduce the overall risk of an investment portfolio, as well as producing a level of income.

It’s also why people often have more of their portfolio in bonds the nearer they get to retirement, as there will be less time to replenish the pot if the stock market crashes.

Types of bonds

However, it’s not quite that simple. There are different bond types. Which is most suitable for you will depend on what you’re trying to achieve and your attitude to risk.

First stop are government bonds. These are seen as the safest types – as long as they’re issued by countries with stable administrations who are likely to pay the money back.

Of course, this can be a blessing and a curse. While the money you’ve invested should be relatively safe, the lack of risk means they will offer a lower rate of interest than racier bonds.

Bonds issued by the UK government are known as gilts – a shortened version of gilt-edged securities, referring to when certificates were gilt-edged. US government bonds are often called ‘Treasuries’.

Corporate bonds

Then there are corporate bonds. This means lending money to a company, rather than a government. This means they can be riskier.

The reality is there’s no guarantee your investment will be repaid in full because the company issuing the bond may encounter problems paying its interest payments, or even go bust!

Therefore, while they are generally regarded as being safer than equities, analysis and research are still required before committing your cash.

How bonds are rated

To help you assess the potential risk of bonds, specialist credit agencies assess them and apply a rating based on the issuer’s ability and likelihood of paying back the sum borrowed.

The most trusted will be given a triple A (written as AAA) ranking, then it goes down on a sliding scale through AA, A and BBB.

Generally, any bonds rated BBB or higher will be classed as investment grade, whereas anything below will be known as high yield. This is because riskier bonds need to offer a higher yield to investors in order to tempt them to invest in the first place.

The more risk you’re willing to take, the higher your potential returns. Generally, government bonds are the safest, followed by investment grade and then high yield.

Other asset classes

While equities and bonds are the most favoured, they are not the only asset classes you can invest in. Property, infrastructure, and commodities, for example, are also popular.

FundCalibre has rated funds in each of these asset classes and you can research them all here.

This is step 2 of 5 in our “5 steps to investing” — continue to step 3: Why funds are an easy option. Need to go back to step 1 — What is investing?

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