Spin-Free GUIDES | M&G Investments

spin-free guide to investing Investing | Risk | Equities | Bonds | Property | Income

Contents Introduction to spin-free guides 3 Where could you invest? 4 Where you can invest: Bonds 5 Where you can invest: Property 6 Where you can invest: Equities 7 Understanding risk 8 Where you can invest: Multi-asset 9 Some of the ways you can invest 10 Glossary 11 Please refer to the glossary found on page 11 for an explanation of the words highlighted in bold throughout this guide.

guides This brochure is part of our range Spin-free guides aim to give you the basics of spin-free guides: about investing, to help you make informed decisions about your financial goals and how Investing to reach them. Equities The value of investments, and the income from them, will fluctuate which will cause the fund price to fall as well as rise and you may not get back the original amount you invested. We are unable to give financial advice. Risk Income If you are unsure about the suitability of your investment, speak to a financial adviser. The views expressed in this document should not be taken as a recommendation, advice or forecast. Bonds Property 3

Where could you Introducing the different areas in which to invest When it comes to choosing where to invest, the option you go for is invest? likely to depend on how you feel about risk and what you need from your investment. Cash Bonds Property Equities Or... Cash grows only by the interest Bonds are generally lower risk Commercial property offers Equities have the potential for It is possible to create what’s rate applied to the savings than equities and provide a the combination of a stable, strong growth, but also come called a ‘diversified portfolio’, account. When the interest regular income, with more long-term income and potential with the possibility for greater meaning an investment rate is lower than the rate of growth potential than cash. for some growth. As leases losses. portfolio that is made up of inflation the actual value of This is because bonds typically on commercial property a combination of some or all your savings will go down. The have fixed lifetimes, at the end tend to be quite long, they of cash, equities, bonds and reason why cash savings are of which whoever holds the produce a more secure and property. This might offer perceived to be the safest home bond will be repaid the original regular flow of income than more stability through the ups for your money is because up to price of the bond. With equities, residential property. and downs in markets and £75,000 of your money is secure there is no guaranteed rate – it economies, because different in a bank or building society is always up to whatever the types of investments tend to through the Financial Services market is willing to pay. rise or fall at different times and Compensation Scheme, unlike at different rates. stocks and shares or fixed interest investments which are less secure. Cash savings are perceived to Bonds offer the potential for a Property has the potential for Equities are higher risk than be the safest way to invest, but regular income and tend to be greater returns than bonds over bonds, property and cash, returns are not high. lower risk than property and the long term. However, it tends but they also offer the most equities. to have less growth potential potential for strong growth. than equities. 4

How bonds work Where you can invest: Bonds are basically a type of loan. When you buy a bond, you are lending money to whoever issued the bond. Most commonly, this Bonds is a company or a government. In return, they’ll pay you a regular When you buy a bond you interest (known as the ‘coupon’) and at the end of the loan (at the are lending money to a ‘maturity’ date), you should get your original investment back. government or company While you can hold a bond until it matures, this is not necessary in that issued the bond order to get a return from your investment. After you buy a newly issued bond, you can sell it at any point before the bond matures. The borrower should give Ways to invest you regular interest payments You can buy bonds yourself or you can invest in a fund that buys in return, plus the original a wide range of bonds. A fund can give you greater diversification amount back at the end through a mix of different bonds from different issuers, but the of the loan income paid out by the fund to you won’t be fixed because the mix of bonds it holds usually changes over time. The value of investments, and the income from them, will fluctuate. Interest is the main return you This will cause the fund price to fall as well as rise and you may not get from bonds, but bond get back the original amount you invested. prices can also rise or fall For more information see our Spin-free guide to bonds. Factors that influence the ‘market price’ of a bond: A bond’s original price (called the ‘face value’) is set when it is issued, but thereafter, the market price will either go up or down when the bond is bought and sold. The market price of a bond is mainly influenced by three key factors: Inflation Interest rates Credit ratings As inflation (or the general price of goods The official interest rate in the UK is set by These are assessments of how likely it is and services) increases, the fixed level the Bank of England. Banks and building that the borrower (or organisation issuing of interest paid by a bond becomes less 2societies tend to base their saving and 3the bond) will repay the loan. If a credit 1 valuable. This is why falling or low inflation lending rates on the Bank of England rate. rating falls, it means there is the belief is normally good news for bond prices. If interest rates go up, the fixed interest that the borrower is more likely to default, paid by a bond becomes less appealing, so the price of the bond tends to fall as as you may be able to get the same return well. Conversely, if the borrower’s credit from a cash savings account. Therefore, rating improves, the price of the bond the price of bonds tends to fall. Conversely, tends to rise. if interest rates go down, the fixed interest paid by a bond becomes more appealing, and so the price of bonds tends to rise. 5

How property investing works You can put your Where you can invest: Property investing isn’t just about buy-to-let. Another option is to money in residential invest in commercial property. This means the buildings used by property or commercial Property businesses, such as offices, shopping centres and factories. property What are the advantages? Commercial property offers the potential for a steady return that is mainly made up of the rental income paid by tenants, though there Commercial property is also scope for capital growth. Returns from property investments offers a number tend to be quite different to that from other asset classes, so if you of advantages have a sizeable portfolio, an investment in commercial property for investors over could help you diversify and produce more stable returns. residential property Ways to invest It’s very hard for individuals to invest in commercial property directly, as it tends to require large sums of money to buy a building. Rental Commercial and default – albeit less likely than with residential property – is still a residential property potential disadvantage, along with less liquidity and maintenance offer security of costs. However, this is not all bad news, as there are many funds you income as well as can invest in that either buy commercial property or hold the shares capital growth of companies that manage/develop properties. For more information see our Spin-free guide to property. The differences between residential and commercial property Commercial property is normally a more stable investment than residential property. There are three main reasons for this: Leases The value of investments, and the The leases tend to last much longer – income from them, will fluctuate. five to ten years, compared with the six This will cause the fund price to months to a year of residential letting. 1 fall as well as rise and you may Tenants not get back the original amount The tenants normally have access to you invested. much larger sums of money, so it’s less 2likely they will fail to pay their rent. Notice periods The notice periods are normally longer, so there’s more time to find a new tenant 6 3when a company decides to move on.

How equities work Where you can invest: When you buy equities, you become part-owner of a company, and so you can have a share in its profits. Clearly, there is also the Equities potential for loss if the company goes bankrupt or if the shares are worth less than when they were bought. Ways to invest You can buy equities yourself or you can invest in a fund that buys a wide range of equities. A fund can spread risk between a mix of different equities from different businesses across a range of industries and countries. However, any income paid out by the fund to you won’t be fixed because the mix of equities it holds usually changes over time. In addition, your investment can go up as well as down and you may not get back your original investment. For more information see our Spin-free guide to equities. There are two ways you can potentially receive a return from your investment: Equities are shares in a company, so A change in the share price Dividends investing in shares The value If the company does well, its shares are likely to Some companies also pay a portion of their profits makes you part-owner of your become more desirable, which means the price to shareholders in the form of dividends. These of the business investment is 1should rise. This means your investment will 2 aren’t guaranteed, as they depend on the company’s likely to rise or probably be worth more than you paid for it when business strategy and how well it is doing. In some fall with the you come to sell it. cases, companies prefer to reinvest most or all of You could also company’s their profits back into their business with the aim receive a share successes or On the other hand, when a company struggles, the of driving future growth. of the company’s failures share price may fall, so the value of your investment profits in the form will drop as well. If you invest directly in shares, any dividends will of dividends be paid to you. However, if you invest through a fund (these are introduced on page 10), the dividends will be paid to the fund. You can then choose whether you want to receive them as a regular income or reinvest them to increase the size of your investment. 7

Managing risk Understanding Wherever you choose to put your money, there will be some level of risk involved. But risk is not necessarily a bad thing. It does mean Risk your investments could fall in value, and you may not get back your original investment, but higher risk also has the potential to produce greater returns. The important thing is to make sure you Risk describes the aren’t taking on any more risk than you need to. potential for losses For more information see our Spin-free guide to risk. Taking some risk is a part of investing There are strategies to help ensure you don’t Here are four strategies to help you manage risk: take more risk than you need to Invest in funds Diversify When you put your money in a fund, it is combined If you hold a blend of investments, they have the with investments from many other people. This potential to perform well, or badly, at different times, 1means it can be spread across a much wider range 2 which reduces the risk of your overall investment of investments than you could buy on your own – so falling significantly in value. One way to diversify you are less exposed to any one holding falling or your investments is to combine higher-risk funds rising in value. focusing on equities with lower-risk funds focusing on property, bonds or even cash. Invest for the long term Invest regularly Markets can drop suddenly at times, often in Investing on a regular basis (such as once a month) reaction to political or economic news. A long-term means you’ll make some investments when markets 3perspective shows that asset price fluctuations 4 are rising and some when they’re falling. This can tend to even out and, over a period of ten years help smooth out some of the ups and downs in the or more, history has shown that markets have markets’ performance. generally risen. 8

A blend of everything Where you can invest: Equities, bonds, cash and property all have advantages and risks. Different funds offer A combination of these asset classes could be an option for some different blends of Multi-asset investors. Investing in different types of assets means you can income and growth create a portfolio with the potential to do what you want, at a level potential of risk you are comfortable with. Find what you need There are many different multi-asset funds in which you can invest. This means you should be able to find one that is balanced for the Holding a blend of asset particular blend of income and growth you are looking for. classes (ie investing in The value of investments, and the income from them, will fluctuate. a multi-asset portfolio) This will cause the fund price to fall as well as rise and you may not can lead to more steady get back the original amount you invested. performance You can do this yourself or invest in a fund that Two ways to create a multi-asset does it for you portfolio You can do this yourself, of course – either by investing directly in a blend of asset classes or by holding a selection of different funds. However, investors can also choose an actively managed multi- asset fund that has the freedom to invest across a range of equities, bonds, property, cash and, at times, currencies. An advantage of this approach is that the investment decisions are made by experienced fund managers, who would look to combine assets that are attractively priced and have the potential to perform differently in different market conditions. Just as importantly, the fund managers should know when to make changes to their holdings in response to changes in the market environment. 9

Some of the ways you can invest In a nutshell You can buy equities and bonds directly – even commercial property You can invest in in some cases – or you can invest in them through funds. These pool many asset classes money from many investors, so they can give you access to a much directly wider range of opportunities than you could invest in on your own. There are then several types of accounts you can hold your funds in. You can hold Alternatively, you your funds in Types of fund Examples of accounts can hold them accounts that available in a fund protect your Unit trusts and Open-Ended Investment investments Companies (OEICs): Individual Savings Account (ISA): from tax You’ll often see unit trusts and OEICs An ISA is not an investment in itself – it’s described as ‘open-ended’. This means they an account that protects your investments can create more units or shares whenever (whether equities, bonds or cash savings) someone wants to invest, so the price of the from tax. In particular, if you are a UK units or shares always reflects the value of taxpayer, you don’t pay capital gains tax on the investment. growth, income tax on interest or higher rate Investment trusts: tax on dividends. These are ‘closed-ended’ funds, which means Junior ISA: they have a limited number of shares. They This has the same tax advantages as an are also companies in their own right, so ISA, but is designed for UK-resident children their shares are traded on stock exchanges. under the age of 18. You can transfer Child As a result, their share price can be higher Trust Funds into Junior ISAs, but you can’t or lower than the value of the investments hold both. they hold. ISA tax advantages depend on your individual circumstances and ISA tax rules may change in the future. 10

Glossary Investment terms The following are explanations of some of the terms you would have come across in this guide. Asset Default Maturity Anything having commercial or exchange value that When a borrower does not maintain interest The length of time until the initial investment Ais owned by a business, institution or individual. payments or repay the amount borrowed when due. amount of a fixed income security is due to be repaid to the holder of the security. Asset class Diversified/Diversification Category of assets, such as cash, equities (or The practice of investing in a variety of assets. This Open-Ended Investment Company (OEIC) company shares), fixed income securities and their is a risk management technique where, in a well- A type of managed fund, whose value is directly sub-categories, as well as tangible assets such as diversified portfolio, any loss from an individual linked to the value of the fund’s underlying real estate. holding should be offset by gains in other holdings, investments. thereby lessening the impact on the overall portfolio. Bond Par value A loan in the form of a security, usually issued by Dividend The initial price of a bond, also known as face value. a government or company, which normally pays a Dividends represent a share in the profits of fixed rate of interest over a given time period, at the a company and are paid out to a company’s Portfolio end of which the initial amount borrowed is repaid. shareholders at set times of the year. A combination of investments held by an investor. Capital growth Equities Risk Occurs when the current value of an investment is Shares of ownership in a company. The chance that an investment’s return will be greater than the initial amount invested. different to what is expected. Risk includes the Face value possibility of losing some or all of the original Coupon The initial price of a bond, also known as par value. investment. The interest paid by the government or company that has raised a loan by selling bonds. Inflation Unit trust The rate of increase in the cost of living. Inflation is A type of managed fund, whose value is directly Credit rating usually quoted as an annual percentage, comparing linked to the value of the fund’s underlying An independent assessment of a borrower’s ability the average price this month with the same month investments. to repay its debts. A high rating indicates that the a year earlier. credit rating agency considers the issuer to be at low risk of default; likewise, a low rating indicates high Issuer risk of default. Standard & Poor’s, Fitch and Moody’s An entity that sells securities, such as fixed income Z are the three most prominent credit rating agencies. securities and company shares. Default means that a company or government is unable to meet interest payments or repay the initial investment amount at the end of a security’s life. 11

Contact us If you would like to get in touch with us you can contact us in the following ways: Call us* Write to us: Customer Relations M&G Customer Relations 0800 390 390 PO Box 9039 If you have a query regarding your M&G investment. Chelmsford CM99 2XG Investment Helpline 0800 389 8600 If you would like to make an investment, request Learning Zone further information on a new or additional investment, Educational guides to help you on your investment or want to read more about our products and services. journey. Our Customer Relations team and Investment Helpline www.mandg.co.uk/learningzone can be contacted from 8.00am to 6.00pm, Monday to Friday, and from 9.00am to 1.00pm on Saturday. Minicom telephone * For security purposes and to improve the quality of our service, we may record and 0800 917 2295 monitor telephone calls. If you have hearing difficulties, you can contact us on If you would like to request a copy of the Important Information for Investors minicom from 9.00am to 5.00pm, Monday to Friday. document, a Key Investor Information Document or the Prospectus, free of charge and in English, please call Customer Relations free on 0800 390 390. This financial promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides ISAs and other investment products. The company’s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No. 90776. APR 16 / W124406

spin-free guide to risk Investing | Risk | Equities | Bonds | Property | Income | Multi-asset

Contents What exactly do we mean by risk? 3 Risk versus reward 4 Balancing risk – too much or too little? 5 Different types of investment and their level of risk 6 Find your level of risk 7 Common types of risk with investment 9 Ways to diversify and manage your risk 12 A few final reminders on risk 14 Glossary 15 Spin-free guides 16 Please refer to the glossary found on page 15 for an explanation of the words highlighted in bold throughout this guide. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to a financial adviser. The views expressed in this document should not be taken as a recommendation, advice or forecast.

What exactly do In life, risk is generally seen as something to be avoided. With investment, risk could be beneficial. A higher risk investment doesn’t mean an investment to be avoided – it simply means the we mean by outcome is less certain. risk? The level of risk you take should depend on your investment goals. If you’re investing for the long term, you may choose a higher risk investment. If you’re investing for the short term, you may choose not to take a lot of risk. Risk in a nutshell When you think about risk in life, you think about Which road you choose depends on your goals – the potential hazards or increased levels of danger. Risk traffic-free road will get you there eventually but if in finance and investment means something slightly your goal is to get there faster, you may take the direct different – it simply means the level of uncertainty in route, and take the risk of getting stuck in traffic. the outcome of your investment. Deciding your goals All investments carry a level of risk, and a higher risk Your investment goals are the first thing you need investment doesn’t mean that you should avoid it at to think about when choosing your level of risk. Your all costs. It simply means that there is less certainty in goals should depend on your individual circumstances, the outcome. attitude to risk and your stage of life. Are you investing When you make an investment, you can never be for the long term to meet a target amount, for example, absolutely certain what you’ll get back when you cash it to pay off the mortgage, save for your children’s in. Risk is implicit in all investments. To achieve a return, education or provide a decent income in retirement? you must therefore be prepared to take some form of If so, you might be prepared to take bigger risks to risk. Even so-called ‘risk-free’ assets are not completely boost returns over a longer timeframe. Alternatively, without risk. you might be saving for the short term or just be looking for a steady income – in which case, it is unlikely Assessing risk that you will want to take much capital risk. Although investment risk is more about uncertainty The reasons you’re investing, the level of risk you’re than danger, you can weigh it up in a similar way to prepared to take and when you’ll need access to your real life risk. For example, there may be two roads into money, should influence the types of investments that town – one a direct route that will get you there faster you make and hold. but could be congested, the other a traffic-free road that circles the town and takes twice as long. 3

Risk versus The more risk you take, the more your investment has the potential to grow. There are no certainties with investments, so taking a higher risk does not guarantee reward a higher return and you may not get back your original investment (known as the capital). The risk/reward ratio explained Be wary of stockmarket The illustration below shows how risk can affect your fluctuations investment. If you choose a low-risk investment, the It’s important to remember that no investment is initial sum invested is not expected to grow very much. guaranteed – the stockmarket will fluctuate so your But if you choose a higher risk investment, your initial investment may not grow as predicted and you may not sum could grow considerably. get back your original sum (capital). Risk is the possibility of losing some, or all, of your capital (your original investment). Risk refers to uncertainty. All investments carry a level of risk. 4

Balancing risk – It might seem sensible to always choose a low-risk investment, but this could leave you too much or without enough money for your needs, especially in the long term. Over-confidence could encourage you to take too much risk – a high-risk investment too little? may have performed well in the past, but that’s no guarantee of future growth. The problem with not taking Balancing the risk enough risk If you’re too cautious with your investment, you may not grow Volatility Timescale your money as much as you’d like to. For example, if you’re investing over the long term for your retirement, but choose Perception Capital growth a low-risk investment, you may not have enough to live on when you come to retire. Tolerance Regular income In the UK people will, on average, need an income to support Risk Your investment themselves for 20 to 30 years after retirement at aged 65. objectives To ensure you have enough to meet your needs, you may choose a higher risk investment early on and then switch to a lower risk investment with a regular income on retirement. The problem with taking too much risk Being too confident and taking too much risk could also leave So although a high-risk investment may grow your money you without enough money for your needs. If you choose a over the long term because you can ‘ride out’ the short- high-risk investment that has performed well in the past, you term dips, putting your money into a volatile investment for may have high expectations of its future performance. But as a short time may leave you with very little growth or less than past growth is no guarantee of future growth, you may not you originally invested. make as much as you expect, which is particularly problematic if you need a certain amount of money to pay off your mortgage or to live on during your retirement, for example. Taking too much risk in the short term could also prove problematic. High-risk investments may be volatile, which means they can fluctuate quite a lot year on year. 5

Different types of Saving in a bank or building society is low risk, but your money also has the least investment and opportunity to grow here. their level Bonds and equities give you more opportunity to grow your money, but your original investment (capital) is not secure. of risk Investing in property is considered relatively stable compared with the returns from bonds and equities, but your capital is still at risk. Whatever your investment objectives may be, it is Investing in equities important to be sure that your portfolio’s balance Equities are shares in a company. The growth of your between risk and return is right for you. For example, investment depends on the fortunes of that company, taking on too much investment risk could result in your the industry it operates in and the general economic capital fluctuating, while not taking enough risk may climate. Although there is no limit to how much your mean that your investment may struggle to meet your investment could grow, there is also no limit to how capital growth requirements. much a share price can fall as well. You may not recoup Investing in a bank or your original investment. building society Investing in property Up to £75,000 of your money is safe in a bank or The amount of income you can make from property building society as it is covered by the Financial Services can fluctuate according to the general trends of the Compensation Scheme. But your money will only grow residential or the commercial property market in the in line with interest rates, so when interest rates are low, economy. Although property is considered more stable as they are currently, your capital growth is quite limited. than equities, your initial investment is still not secure. Investing in bonds For more information please see our Spin-free guides to Investing in bonds is like giving a fixed-term loan to a bonds, equities and property. company (or a government). You can receive income from interest on the ‘loan’ for an agreed length of time. Bonds are considered to carry less risk than other types of investments; however, the amount of risk varies according to how secure the bond issuer is considered to be. Bonds issued by governments are generally considered to be more secure. 6

Make sure you are comfortable with the level of risk you decide to take with your Find your level investment. of risk Choose an investment portfolio with the right balance of risk and return for you. The length of time during which you can invest, combined with your investment goals, will help you choose the right level of risk for you. How to find your level of risk As you’ll have read on page 5, there are problems with your investment. To find the level of risk that’s right for taking too much risk and not taking enough risk with you, you need to think about your plans: How much time How much money do you have would you like to have to allow your at the end of your investment to grow? investment period? £ 7

Find your level of risk continued Performance of dierent asset classes over 25 years (£1,000 initial investment) adjusted for inflation £5,000 UK equities Bonds Commercial property UK building society £4,000 £3,000 £2,000 £1,000 £0 Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Stockmarket prices may fluctuate and you may not get back the amount that you originally invested. Past performance is not a guide to future performance. UK Equities shows the performance of £1,000 invested in the FTSE All-Share Index over 25 years with net income reinvested. Bonds shows the performance of £1,000 invested in the FTSE All Stocks Index over 25 years with gross income reinvested. Commercial Property shows the performance of £1,000 invested in the IPD Index over 25 years with net income reinvested. UK Building Society shows the performance of £1,000 invested in a typical building society account (where up to £75,000 of your money is secure through the Financial Services Compensation Scheme, unlike a stocks and shares or fixed interest investment which are less secure) over 25 years with net income reinvested. Source: Morningstar and M&G Statistics, to end Sep 2016. Your personal investment timeframe and your individual to your investment than bonds or property. On the circumstances (for example, your age and stage of life) other hand, cash carries the lowest level of risk, but as will give you an idea of whether it would be appropriate to a result, has historically produced the lowest returns. take more risk in order to achieve your investment goals. We believe that regularly reviewing your portfolio is Different asset classes have different risk and return fundamental to long-term success. profiles. For example, equities may produce the highest long-term returns, but depending on the prevailing economic situation, they may also carry a greater risk 8

Common types Each type of investment (asset class) has its own level of risk and return. of risk with The risk and return profile of an asset class is based on past performance and market conditions. investment Asset classes are affected by a number of different types of risk – some types of risk are common to all asset classes. Common types of risk explained As share prices fluctuate according to company We introduced you to different asset classes on page 6 performance, stockmarket trends and other factors, of this guide. Each asset class can be affected by one or there is greater capital risk. While there is no limit to more types of risk. how much a share price can rise, there is also no limit to how much it can fall – you may not get back the Here are some common types of risk and a guide to initial sum invested. the asset classes affected by them: Capital risk Capital risk in bonds When you invest in bonds, you ‘loan’ a company Every investment, even cash above £75,000, carries the or government your money over a fixed period risk that you may not get back your initial sum invested of time. That company or government will pay (capital). This is known as capital risk. you ‘interest’ on the loan for the length of the bond As we explained before, equities and bonds carry a period, at the end of which it will pay back your capital. higher capital risk than cash. But out of the two, equities The capital risk in bonds comes if the company or has a greater capital risk. government goes bankrupt during your investment Capital risk in equities period. But even if that happens, bondholders are more Equities are shares in companies. When you buy equities likely to recover some of their losses than shareholders. you become part-owner of the company and your investment successes depend on the fortunes of the company. 9

Common types of risk with Currency risk investment This is a risk associated with investing overseas or in continued international companies. As a UK-based investor, if you invest overseas, you’ll need to convert your money back into sterling when you want it back. As currency exchange rates change, Credit risk so will the value of your investment. This is a risk associated with bonds. If sterling strengthens against the currency of the If a company or government that has issued bonds country in which you’ve invested, this will lower the (also known as the issuer) fails to make interest payments value of your foreign investment. If sterling weakens, or repay the initial loan amount, a ‘default’ occurs. your foreign investment will increase in value. Each issuer has a credit rating that indicates its ability Inflation risk to pay back its loans. If an issuer’s credit rating is Inflation risk can affect all types of assets. downgraded (by a credit rating agency) it suggests that The higher the rate of inflation, the lower the actual the risk of it defaulting has increased, and the value of value of future returns. This is because as the rate of bonds issued by the company or government could fall. inflation increases, money devalues in real terms. For If this happens, an issuer might choose to offer higher example, you can’t buy as much with £5 today as you interest payments to entice investors who are taking could 30 years ago. a greater risk by lending money to that company or government. As you’ll remember from the graph on page 8, inflation Governments with solid public finances typically have causes a purely cash investment to devalue over time. a lower probability of default on their debt. Therefore, So ideally, any investment you make must beat the rate they are more likely to pay a lower level of interest. of inflation to grow your money in real terms. Companies tend to offer larger interest payments on their bonds to compensate for the higher risk that they could default. 10

Common types of risk with investment continued Interest rate risk Market risk This type of risk affects cash savings and inversely Market risk can affect all types of investment. affects bonds. Market risk is the risk of an entire market collapsing Bank and building societies will increase or decrease the rather than just an individual company. This could interest they pay on deposits in line with the Bank of happen as a result of an economic shock or a major England’s rates. So if interest rates are low, your cash institutional failure that triggers a chain reaction savings in a bank or building society may not grow affecting the entire market. very much. Generally, bond prices tend to move in the opposite direction to interest rates. When interest rates go up, the fixed payments offered by bonds look less attractive. But if interest rates are low, the fixed payments look more attractive and may be more than you might get from your bank or building society. 11

Ways to diversify Plan your investments well and you’ll also manage your risk well. and manage Even if you’ve chosen a portfolio that suits your level of risk and needs, you should review your level of risk and investment goals on a regular basis. your risk Diversification is the key to minimising your risk. Ways to minimise risk Diversification Investing in funds Quite simply, don’t put all your eggs in one basket. By investing in a fund rather than an individual A diversified portfolio that includes higher risk company, your money is spread across shares or bonds investments, such as equities, as well as lower risk from many different companies, sectors and, in some investments, such as bonds, will help to manage and cases, regions. The risk to the overall investment is lower your risk. This is because if the equities in your reduced since you are not relying on the fortunes of a portfolio are volatile and dramatically decrease in value, single entity. If one company in the fund underperforms, the fixed interest from your bonds should still give you the others could cushion the blow. a regular income and help to give your investment an The cost of investing in a fund can often be less than overall consistent level of performance. buying shares or bonds one at a time. This is because the costs are generally lower, the larger the sums involved. Also, an experienced fund manager can select and manage those assets on your behalf. 12

Ways to diversify and manage your risk continued Investing for the long term Investing regularly As you’ll remember from the graph on page 8, while Investing at regular intervals can also help reduce the value of equities may fluctuate month on month, risk because markets rise and fall all the time. When it can increase over a longer time period. Many types the market price is low, a greater number of shares or of investment take a tumble for all kinds of reasons bonds can be bought for the same money. At other (see previous section on common types of risk), but if times, when the market is high, the opposite is true. you invest for the long term, it’s possible to ‘ride out’ If you buy continuously through the ups and downs, these short-term fluctuations. But please note, there the average price of the investment can be lower than is no guarantee of future growth in any market or if you make one lump sum investment. Of course, when investment type. the market falls, the existing investment will be worth The longer you invest, the bigger the potential effect of less. But, over time, regular investments can help to compound performance on the original value of your smooth out the market’s peaks and troughs. investment. Many of you will be familiar with the term ‘compounding’ from owning cash savings accounts. Compounding refers to the process whereby interest on your money is added to the original principal amount which then, in turn, earns interest. Your investments can benefit from compounding in a similar way, if you reinvest any income you receive, although you should remember that the value of stockmarket investments will fluctuate, causing prices to fall as well as rise and you may not get back the original amount you invested. 13

A few final The level of risk that’s right for you will depend on your stage in life and your future plans. reminders If your life plans change, your attitude to risk may change too, so you’ll want a portfolio that’s flexible enough to change with you. on risk Don’t forget that not taking enough risk can be just as problematic as taking too much risk. Don’t forget… Important note Choosing your level of risk is all about the reward The views expressed in this document should you’re seeking. Think about your life plans and when not be taken as a recommendation, advice or a and how you’ll want a return on your initial investment forecast. The value of stockmarket investments (capital). Once you’ve decided this, you’ll know what will fluctuate, causing fund prices to fall as well type of risk is right for you. as rise, and you may not get back the original amount If you’re saving for retirement, for example, you may you invested. Past performance is not a guide to be willing to take a higher risk earlier in your life for future performance. potentially higher returns. This is because even if your investment doesn’t perform well, you still have time to make other plans. But closer to your retirement age, you may choose to switch to a lower-risk investment to help protect your capital. 14

Glossary Investment terms The following are explanations of some of the terms you would have come across in this guide. Asset Dividends Volatile Anything having commercial or exchange value Dividends represent a share in the profits of When the value of a particular share, market or Athat is owned by a business, institution or individual. a company and are paid out to a company’s sector swings up and down fairly frequently and/or Asset class shareholders at set times of the year. significantly, it is considered volatile. Category of assets, such as cash, company shares, Equities Volatility fixed income securities and their sub-categories, Shares of ownership in a company. The degree to which a given security, fund, or index as well as tangible assets such as real estate. Portfolio rapidly changes. It is calculated as the degree of Bond deviation from the norm for that type of investment A combination of investments held by an investor. over a given time period. The higher the volatility, A loan in the form of a security, usually issued by the riskier the security tends to be. a government or company, which normally pays a Return fixed rate of interest over a given time period, at the The amount of money you’ll make from an end of which the initial amount borrowed is repaid. investment. Capital Risk Z Refers to the financial assets, or resources, that A ratio comparing the expected returns of an a company has to fund its business operations. investment with the amount of risk undertaken. Capital growth Risk/reward ratio Occurs when the current value of an investment is A ratio comparing the expected returns of an greater than the initial amount invested. investment with the amount of risk undertaken. Diversification Shareholder The practice of investing in a variety of assets. This Someone who owns at least one share in a is a risk management technique where, in a well- company – they are part-owner of that company diversified portfolio, any loss from an individual through the shares they have. holding should be offset by gains in other holdings, thereby lessening the impact on the overall portfolio. 15

spin-free guide to equities Investing | Risk | Equities | Bonds | Property | Income

Contents What are equities? 3 How you could make money from equities 4 Understanding how equities increase or decrease in value 5 Equities compared to other types of investment 6 Are equities right for you? 7 Questions you’ll want to ask before investing 8 Glossary 10 Spin-free guides 11 Please refer to the glossary found on page 10 for an explanation of the words highlighted in bold throughout this guide. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to a financial adviser. The views expressed in this document should not be taken as a recommendation, advice or forecast.

What are An equity is a share in a company Buying shares makes you part-owner of the company equities? Because you are part-owner, the value of your investment will rise or fall with the company’s successes or failures Equities in a nutshell When you buy equities, you become part-owner of the Primary market: when a company sells its shares to company and have a share in its profits. As you buy investors for the first time on a stock exchange, such as more equities, your share in the ownership of the company the London Stock Exchange. This is called an Initial Public becomes greater. You may also have certain voting rights Offering (IPO). IPOs may be available to all investors or if you buy the shares directly; however, generally, you will may be restricted to institutions only, such as pension have very little say in how the company is run. Usually, funds, insurance companies and investment funds. if you own shares with voting rights you will be entitled to one vote per share to elect the board of directors at Secondary market: Once shares are issued through annual general meetings. an initial public offering, they can then be sold and subsequently bought by other investors on the secondary How do they work? market of the stock exchange. That is to say, secondary A company will sell shares to raise money for the business – markets enable the buying and selling of previously to expand, to invest in new ventures, or sometimes to pay owned shares. off its debts. A company may choose to issue and trade shares through the following ways: 3

How you could Income from shares make money from Share prices rise and fall depending on supply and demand. Interpretation equities of company news, economic data and information regarding the industry or competitor companies will all affect the number of buyers and sellers of a share at any point in time. Share prices change constantly and participants in the market will make different assessments of the value of the company. When a company is successful, the price of each share is expected to rise. When it’s less successful, the share price is expected to fall. If you sell shares at a higher price than you bought them, you should make a profit from them. Share prices rise and fall depending Income from dividends on supply and demand You don’t have to sell your shares to make money from them. As a shareholder, you are part-owner of the company you invest in. You can make money from shares if you sell them at a higher price than Sometimes companies choose to give shareholders a percentage of its profits at you paid for them intervals. If the company you invest in does this, you can earn an income through dividends. Dividends are a percentage of profits paid out by the company on a Dividends are another way of regular basis (usually quarterly) directly to its shareholders. making money from shares – this is a percentage of profits from When you’re thinking about investing in equities, you should find out if the company the company distributed to its or companies you’re considering pay out dividends and if so, how they’re paid. shareholders If you’ve invested in equities through a fund (where investors pool their money and a fund manager invests on their behalf), the dividends are paid to the fund. The fund may pass the dividends to its investors in the form of distributions. Before investing, you may wish to find out whether a fund makes distribution payments, and if so, how frequently. More on investing through funds later. As a shareholder, you are part-owner of the company you invest in. 4

Understanding how equities increase or decrease in value How supply and demand affect equities If a lot of investors would like to buy shares in a company, but not many existing shareholders want to sell, this is likely to push the share price up. The opposite is also true – if more people want to sell shares than want to buy them, the price is likely to go down. How a company’s performance affects equities A company will issue statements about its expected earnings and profitability in the coming months and years, and investors use this information to decide whether or not to buy or sell shares. This affects supply and demand, which ultimately determines the share price. How market trends and outside factors can affect equities If reports from research analysts predict a company is likely to do well, this may Supply and demand have a big increase demand for its shares and push up the share price. On the other hand, influence on the value of an equity if the reports say a company will likely perform less well in the future, the share price may fall. If more people want to buy shares in a company, the price is likely to rise – if Outside factors, such as how a competitor company is performing or acquisitions more people want to sell, the price is and mergers, can also influence share prices either positively or negatively. likely to fall Speculation about a company’s stability and future growth can also affect the share price 5

There are many ways to invest your money: in a bank or building society, in property, in Equities compared to bonds or in equities – these are just a few of the options other types of Cash savings are perceived to be the safest way to invest but returns are not high investment Bonds are like a fixed-term loan to a company – they offer the potential for a regular income and tend to be lower risk than property and equities Bonds can give you a regular income through interest payments Equities are higher risk than cash savings or bonds but also offer the most potential for strong growth Differences between equities and bonds Choosing between equities and bonds depends on the level of risk you’re willing to take and whether you want a regular income or you want your initial investment to grow. Equities represent a share in a company’s assets. While equities can enjoy higher returns in the longer term than fixed income securities – also known as bonds – they can also pose greater risk to your capital. Equities could be right for you if you are comfortable with taking a risk and are willing to have a variable income from your dividends or distributions. Bonds are debt instruments and can be particularly attractive if you’re looking for regular income. They are generally seen as a more secure investment when compared with equities because there is an obligation to pay the bond holder back. Income from bonds is usually fixed and the price of bonds tends to be less volatile. Bonds could be right for you if you are less willing to take a risk and want a regular income for a given period of time. A diversified portfolio made up of both bonds and equities could give you more stability as the market rises and falls. 6

Equities could give you higher returns than other investments but they Are equities right are higher risk for you? Equities are more suited to long-term investment – that way your money can ride out short-term dips in the market years. The value of investments will fluctuate, which will cause fund prices to fall as well as rise and you may not get back the original amount you invested. Equities could grow your money Equities as part of a more than cash or bonds diverse portfolio Looking at past information, shares have tended to perform Choosing equities as part of a diverse portfolio that includes better than investing your money in bonds, cash savings other types of investment, such as bonds or cash savings, or property. Past performance is no guarantee of future means that you could lower your overall risk while still performance. potentially benefiting from the higher returns equities may Up to £75,000 of your money is secure in a bank or building give. The percentage you invest in equities should reflect society through the Financial Services Compensation the level of risk you’re willing to take. Scheme, unlike stocks and shares or fixed interest investments Different ways you can invest which are less secure. in equities Equities can carry more risk Direct: You can invest directly in equities by going through a because they’re unpredictable stockbroker or using an online trading site. This can involve The benefit of equities is that there is no limit to how high time and resources to manage your investments and can the price of a share could rise – no cap on how much you sometimes prove to be expensive. could make from your investment. But with this benefit Fund: invest through a fund and you’ll pool your capital comes a risk – there’s also no limit to how low a share price with other investors to buy equities. Different types of could fall and the company could go bankrupt, making your funds have different investment objectives, for example, shares worthless. investing for capital growth or investing for regular income, Equities are more suited to or sometimes both. long‑term investment Funds typically impose a fee to manage your investments. If you are not looking for a quick return on your money, This is normally referred to as ongoing charges. investing directly in equities or an equity fund may be right for you. Investing for the long term means although there may be short-term dips in the share price from month 7 to month, there could be an overall rise after three to five

What’s the aim of the fund you’re investing in – to grow your money, Questions you’ll want generate a regular income or give you a total return? to ask before What’s the level of risk involved and how will it be minimised by the fund investing manager running it? How does the fund manager engage with company management? Choosing a fund with the right You should also decide on the outcome you’d like from this aims, objectives and charges investment – whether you’d like regular income, long-term growth or both (called a total return) will help you choose Choosing the right equity fund depends on your investment the fund that’s right for you. goals – are you looking for an income from your investment, to grow your initial investment or to benefit from both? How does your fund manager Asking your financial adviser or researching the aims of a engage with company fund and the types of investment it makes will help you decide if it’s right for you. management? Different types of fund and investment companies impose If your fund manager’s investment firm has an analyst team different fees. Therefore, investors should be aware of this to research companies, your fund manager will benefit from when choosing their investments. relevant information about the marketplace. This specialist expertise complements the fund managers’ more generalist Make sure you have determined knowledge and focus. your investment needs and your With this added knowledge, they should be able to make level of risk more informed investment decisions on your behalf. The fund you choose could be a low risk/low return or a high risk/high return fund. You should decide on the level of risk you’re willing to take before looking for the right fund. It is important to understand the level of risk involved in a fund, and the methods by which the fund manager may seek to manage risk. 8

Questions you’ll want to ask before investing continued What is an ongoing charge? Ongoing charges are payments deducted from the assets Tracker fund: a tracker fund follows the ups and downs of of a fund. They only include direct costs to the fund that a market index. Your investment will increase or decrease in will affect the client. This is based on the total of all value in line with the performance of that index. A tracker charges made over a year, and includes charges such as fund is ‘passive’ because it simply follows a chosen index. the fund’s annual management charge, custodian charge and administration charge. Please note, for an actively managed fund, there are typically higher fees imposed than with a passive/tracker Broadly, there are two types fund. of fund: Actively managed fund: this is where an experienced fund manager invests and manages on your behalf. Investing in this way gives you the benefit of the fund manager’s experience and expertise as well as the resources of the investment house they’re part of. 9

Glossary Investment terms The following are explanations of some of the terms you would have come across in this guide. Asset Diversified/Diversification Issue Anything having commercial or exchange value that The practice of investing in a variety of assets. This A set of shares/bonds that were released at a Ais owned by a business, institution or individual. is a risk management technique where, in a well- particular time. Actively managed diversified portfolio, any loss from an individual Issuer Your investment is looked after by a fund manager holding should be offset by gains in other holdings, An entity that sells securities, such as fixed income who will use your invested money (capital) to buy thereby lessening the impact on the overall portfolio. securities and company shares. and sell shares on your behalf, with the aim of Dividends Primary market beating the average stockmarket returns. Dividends represent a share in the profits of Where equities and other securities are sold by the Bond a company and are paid out to a company’s issuer to the purchaser for the first time. A loan in the form of a security, usually issued by shareholders at set times of the year. a government or company, which normally pays a Equities Total return fixed rate of interest over a given time period, at the Shares of ownership in a company. The term for the gain or loss derived from an end of which the initial amount borrowed is repaid. investment over a particular period. Total return Fixed income security includes income (in the form of interest or dividend Capital growth A loan in the form of a security, usually issued by payments) and capital gains. Occurs when the current value of an investment is a government or company, which normally pays a Volatile greater than the initial amount invested. fixed rate of interest over a given time period, at the When the value of a particular share, market or Distributions end of which the initial amount borrowed is repaid. sector swings up and down fairly frequently and/or Refers to the periodic paying-out of interest or Initial Public Offering (IPO) significantly, it is considered volatile. dividends received by funds to their shareholders. The first sale of shares by a private company to Dividends represent a share in the profits of a the public. Z company and are paid out to the owners of company shares at certain times during the year. 10

spin-free guide to bonds Investing | Risk | Equities | Bonds | Property | Income | Multi-asset

Contents Explaining the world of bonds 3 Understanding how bond prices can rise or fall 5 The different types of bonds 8 Bonds compared with other types of investments 10 How can you invest in bonds? 11 A few questions to ask before you invest in a bond fund 12 Glossary 13 Spin-free guides 15 Please refer to the glossary found on pages 13 and 14 for an explanation of the words highlighted in bold throughout this guide. The value of investments, and the income from them, will fluctuate which will cause the fund price to fall as well as rise and you may not get back the original amount you invested. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to a financial adviser.

Explaining the world of bonds Bonds can seem complicated at times, but if the idea of a regular income appeals to you, it’s worth finding out more about it. If you don’t know your coupon from your credit rating or your principal from your par value, this guide is designed for you. Our aim is to give you the basics, to help you make informed The name’s bond... decisions about your investment aims. Often referred to as bonds, they’re Depending on your situation and your financial goals, investing in bonds could also known as ‘fixed income’ be right for you. But if, after you’ve read this guide, you think you would be or ‘fixed interest’ securities. better suited to something different, there are a variety of other investment It’s likely you’ll come across all options for you to have a look at. These are explained in more detail in our other Spin-free guides; see page 15 for more details. these terms when you read about investments. They all describe the So, what are bonds? same thing, so we’ll just call them A bond is a loan bonds in this guide. When you buy a bond, you are lending money to the government or company that issued it They will give you regular interest payments in return, plus the original amount back at the end of the loan The value of investments, and the income from them, will fluctuate which will cause the fund price to fall as well as rise and you may not get back the original amount you invested. 3

Explaining the Understanding the risks Importantly, there is a chance you won’t be repaid your original investment, world of which is the key risk you face when investing in bonds. It is the reason they are continued considered to be higher risk than just putting your money in a savings account bonds (although bonds are still generally lower risk than investing in company shares, or equities). Where things get a bit more complicated is that bonds can be sold on – just like a company’s shares. This means their price can change. We’ll explain this in more detail on the next few pages. Three words you need to know... Before we go any further, there are three words we need to introduce. They are ‘principal’, ‘coupon’ and ‘maturity’: The principal is the amount you lend to the government or company issuing the bond. The coupon is the regular interest payment that you receive for buying the bond. It is often a fixed amount that is set when the bond is issued. Maturity is the date when the bond expires and the principal is repaid. Returns from bonds Income: coupons You know exactly how much you’ll receive and when, assuming the issuer doesn’t miss payments. Capital return If you buy a bond from another investor for less than its original cost, you could make a profit by holding it to maturity. 4

If you buy a bond when it is issued, you pay a fixed price. However, after it is issued, you Understanding how can trade the bond with other investors, much like you can with shares. When you buy or bond prices can sell a bond in this way, its ‘market’ price will be affected by a number of factors. rise or fall Here we look at the four main influences on bond prices. 1. How interest rates affect bonds Now imagine that the Bank of England decides that The interest rates paid by banks and building societies the economy is growing too fast and decides to raise normally follow the official interest rate set by the Bank the official interest rate, causing the rate on the savings of England. The Bank of England uses this rate as a tool account to move up as well, to 2%. Suddenly, the 1.25% to manage the UK economy. on the bond doesn’t look as appealing, so its price is likely to fall. Equally, if the Bank of England cuts interest rates, When times are tough, interest rates tend to be cut in the the interest on the bond becomes more attractive, so its hope this will encourage consumers to spend, businesses to price may rise. borrow and, through this process, kick start the economy. 2. How inflation affects bonds If things are going well, and consumer spending, as well Things tend to get more expensive over the years. This as bank lending, are starting to look too strong, the Bank rise in prices is referred to as inflation. When inflation is of England could raise the interest rate to slow things high, it can be a problem for bonds because the income down, and reduce the demand for borrowing. they pay has normally been fixed at the time of issue. Normally, bond prices tend to move in the opposite A bond that offers interest of 5%, for example, may sound direction to interest rates. We can illustrate this with a good in isolation, but if inflation is running at 4.5%, the simple example. Imagine you had a choice between a real return, or return after adjusting for inflation, is only savings account that pays interest of 0.5% and a bond 0.5%. This means bonds tend to become less attractive that offers you interest of 1.25%. In choosing where to (and prices fall) when inflation is rising. invest your money, you’d have to take into account the higher level of interest paid by the bond and decide On the other hand, if inflation is falling, a fixed interest of whether it is worth the greater level of risk it involves. 5% becomes a lot more appealing. Therefore, in a situation We’ll look at this risk in more detail on pages 8 and 10. where inflation is falling or low, bond prices tend to rise. 5

Understanding how bond prices can rise or fall continued 3. How an issuer’s prospects 4. How supply and demand affectbonds affectsbonds Some companies find it financially easier than others If a lot of companies or governments suddenly need to to pay their debts. This ability to repay is measured borrow, there will be many bonds for investors to choose by their credit rating, or creditworthiness. It is an from, so prices are likely to fall. On the other hand, if assessment, carried out by independent rating agencies, more investors want to buy than there are bonds on offer, of a borrower’s ability to repay its debt. A higher rating prices are likely to rise. means a company is very likely to meet its payments. What drives the value of bonds up On the other hand, if a company’s financial situation or down? weakens, its credit rating will be downgraded, as there is a greater chance that the company will struggle to make VALUE INCREASES: More investors want to buy, but its payments. As a result, its bond price will often fall, fewer bondholders want to sell. as investors decide that the income offered by the bond isn’t enough to make up for the fact that it is now riskier. VALUE DECREASES: More bondholders want to sell, but The same is true for governments, which are also given fewer investors want to buy. credit ratings by rating agencies. Governments in the developed world, such as the UK or the US, are generally Bonds can be traded like shares considered to be more likely to meet their payments than governments in some developing countries, and so This means their prices can go up or down, tend to be given a higher credit rating than the latter. A depending on a number of factors change in a government’s financial health will therefore These factors include interest rates, inflation and affect its credit rating and, in turn, the price of its bonds. the economic outlook 6

Understanding how Bonds normally pay a pre-agreed regular income bond prices can You should then get the initial investment back when the loan expires rise or fall continued Are bonds right for you? Achieving some growth A key advantage of investing in bonds is that you could As we explained on pages 5 and 6, there are a number receive a stable income and your original investment of factors that can cause the price of a bond to go up or back at the end of the loan. There is also the potential down. While this rise or fall tends not to be as significant for a profit if you sell the bond at a higher price than you as the changes in price that you see with shares, it could paid when you bought it. still allow you to make a profit on a bond if you buy and sell it at the right time. Equally, if a bond falls in value and A stable income you buy it for less than its original cost, you could hold it Because the interest is fixed when you buy a bond, you’ll to maturity and you would make a profit in addition to generally know exactly how much you’ll receive and when any income you receive. (In both cases, it is also possible it will be paid. If you are relying on your investment for to make a loss.) income, the regular interest payments from bonds can The value of your income make it much easier for you to plan ahead – though there Because the price of a bond can change, but the income is always a chance the company or government who you payments are fixed, the return on the bond (often referred have lent your money to will fail to keep up the payments. to as the yield) can vary. For example, a bond issued at Preserving your savings £1 with a 5p coupon, has a yield of 5%. However, if the If you hold your bond for the life of the loan (and nothing price rises to £2, the coupon is still 5p, so the yield falls goes wrong in the meantime), you should get back what to 2.5%. This means that if you are buying bonds from you originally put in. It’s as simple as that. other investors and you need a certain level of income, the price you pay is very important. 7

The different types of bonds Choosing between the different Corporate bonds types of bonds Corporate bonds are issued by companies when they need to raise money to finance their business, or to repay There are many different kinds of bonds in the market, other loans. They are often considered to be higher risk so it’s important to know exactly what you want from than government bonds, because companies generally your investment. In particular, there’s one question you are more likely to have problems paying their debts. need to consider. Are you willing to take on more risk, with the aim of achieving more income, or do you want to keep things as safe as possible? Your answer will help you decide which types of bonds are right for you. The two main issuers of bonds are governments and You can lend money to a companies: country (a government bond) or to a company Government bonds (a corporate bond) Government bonds are issued by countries, normally to raise money for public spending. Among the biggest A higher level of issuers of government bonds are the UK government interest normally means (UK government bonds are also known as gilts), the US a higher level of risk government (their bonds are known as Treasuries) and the German government (bunds). Governments with solid public finances are generally regarded as low risk, as they are less likely to fail to keep up the payments. Therefore, they tend to pay very low coupons, or interest. 8

The different types of bonds continued Bond issuers are normally graded according to their ability to repay their debt. Investment grade bonds A company or government with a high credit rating is While the majority of bonds that are issued pay a fixed considered to be ‘investment grade’. This means you’re level of interest, there are others that pay a flexible rate, less likely to lose money on their bonds, but you’ll probably or adjust their payments in line with inflation. get less interest as well. Index-linked bonds High yield bonds As we mentioned on page 5, inflation can be a real At the other end of the spectrum, a company or problem for bond investors. One possible solution for government with a low credit rating is considered to be investors worried about changes in the inflation rate is index-linked bonds. ‘high yield’. As the company or government issuing them offered by has a higher risk of failing to meet their repayments, The value of the loan and the regular income payments they have to offer a higher level of interest to encourage you receive are adjusted in line with a particular measure people to buy their bonds. of inflation (in the UK, this is usually the Retail Prices Index). This means that when inflation is rising, your coupon payments and the amount you get back will go up in line with the inflation rate, and vice versa. 9

Cash savings are the safest way to invest, but they also have the Bonds compared least chance to grow with other types of Bonds offer the potential for a regular income and tend to be lower investments risk than property and equities Equities (also known as shares) are part-ownership of a company, so you have a share in its profits. They are higher risk than property, bonds and cash, but they also offer the greatest potential for growth Where could you invest? When it comes to choosing where to invest, the option It is possible to create what’s called a ‘diversified you go for is likely to depend on how you feel about risk portfolio’, meaning an investment portfolio that is made and what you need from your investment. up of a combination of some or all of cash, equities, Cash grows only by the interest rate applied to the bonds and property. This might offer more stability savings account. However, it is the most secure home for through the ups and downs in markets and economies, your money. Up to £75,000 of your money is secure in because different types of investments tend to rise or a bank or building society through the Financial Services fall at different times and at different rates. Compensation Scheme, unlike stocks and shares or fixed interest investments, which are less secure. Bonds are generally lower risk than equities and provide a regular income, with more growth potential than cash. Property offers the combination of a stable, long-term income and potential for some capital growth through investing in ‘bricks and mortar’ assets. Equities have the potential for strong growth, but also come with the possibility for greater losses. 10

How can you You can invest directly in bonds You can put your money into a fund where the fund manager chooses invest in the bonds bonds? There are many different types of bond funds to choose from The different ways you can invest in bonds While it is possible for you to buy bonds yourself, it’s not the easiest thing to do and it tends to be quite expensive. An expert perspective Pooling your money Investors may find that it’s much more straightforward You can pool your money with other investors to buy a fund that invests in bonds. This has two main to buy a range of bonds, diversifying your advantages: investments to reduce exposure to any one government or company. Your money is combined with investments from lots An experienced fund manager invests and manages of other people, which means it can be spread across on your behalf. An active manager typically aims to a range of bonds in a way that you just couldn’t do if outperform other similar bond funds. you were investing on your own. Because of the mix of investments, however, bond funds cannot promise a fixed income over time. Funds are normally managed by professionals who are backed by all the research resources of an investment company. This helps them find the best opportunities and avoid bonds that may have problems down the line; however, there’s no guarantee of course that they will be successful. 11

A few questions to What sorts of bonds does the fund invest in? ask before you invest How does the fund manage risk? in a bond How does the manager determine which bonds to invest in? fund Picking a fund that meets to repay its debt. Different bonds are affected differently yourneeds by changes in these two key factors. Before you invest, it’s worth making sure the company managing your bond The names of bond funds can sometimes reveal very fund has the knowledge, experience and resources to little, so it’s a good idea to get a sense of the potential monitor these challenges and make changes whenever risks of a fund by looking at the types of bonds it invests they are required. in and what the average credit rating is of its bond holdings. For example, you can choose between funds Finding out how your fund that invest purely in government bonds, funds that manager’s investment company invest in investment grade corporate bonds, or funds that invest only in high yield bonds, or you could choose researches opportunities a fund able to invest in all the different types. There are few people who would lend money to someone without knowing anything about them. Investing in Checking how the manager bonds is just the same. If your fund manager’s investment produces an income company has its own team of analysts, they can carry Income on a bond fund is produced by the regular coupons out their own in-depth research into the bonds they paid by the bonds held in the portfolio. As you probably might hold. expect, you have to pay for the management of any bond This means they aren’t relying solely on information from fund you invest in. The way these charges are handled will credit rating agencies, which is available to everyone. affect the total income you get. Some funds take their With greater insight, a well-resourced investment team charges from income before it is paid out to you, while should be able to make more informed decisions on others take it from the amount you originally invested. your behalf. Making sure you are happy with the way a fund manages risk The returns from bonds are primarily influenced by changes in interest rates and the ability of the borrower 12

Glossary Investment terms The following are explanations of some of the terms you would have come across in this guide. Bond Credit rating Fixed income security A loan in the form of a security, usually issued by An independent assessment of a borrower’s ability A loan in the form of a security, usually issued by Aa government or company, which normally pays a to repay its debts. A high rating indicates that the a government or company, which normally pays a fixed rate of interest over a given time period, at the credit rating agency considers the issuer to be at low fixed rate of interest over a given time period, at the end of which the initial amount borrowed is repaid. risk of default; likewise, a low rating indicates high risk end of which the initial amount borrowed is repaid. Bunds of default. Standard & Poor’s, Fitch and Moody’s are Also referred to as a bond. Fixed income securities issued by the German the three most prominent credit rating agencies. Gilts government. Default means that a company or government is Fixed income securities issued by the UK government. unable to meet interest payments or repay the initial Capital return investment amount at the end of a security’s life. Government bonds The term for the gain or loss derived from an Default Fixed income securities issued by governments, investment over a particular period. Capital return When a borrower does not maintain interest that normally pay a fixed rate of interest over a includes capital gain or loss only and excludes income payments or repay the amount borrowed when due. given time period, at the end of which the initial (in the form of interest or dividend payments). investment is repaid. Corporate bonds Diversified/Diversification High yield bonds Fixed income securities issued by a company. The practice of investing in a variety of assets. This Fixed income securities issued by companies with a low They are also known as bonds and can offer higher is a risk management technique where, in a well- credit rating from a recognised credit rating agency. interest payments than bonds issued by governments diversified portfolio, any loss from an individual They are considered to be at higher risk of default as they are often considered more risky. holding should be offset by gains in other holdings, than better quality, ie higher-rated fixed income thereby lessening the impact on the overall portfolio. securities but have the potential for higher rewards. Coupon Equities ‘Default’ means that a company or government is The interest paid by the government or company Shares of ownership in a company. unable to meet interest payments or repay the initial that has raised a loan by selling bonds. investment amount at the end of a security’s life. Face value The initial price of a bond, also known as par value. continued on next page 13

Glossary continued Inflation Issuer Risk The rate of increase in the cost of living. Inflation is An entity that sells securities, such as fixed income The chance that an investment’s return will be different usually quoted as an annual percentage, comparing securities and company shares. to what is expected. Risk includes the possibility of the average price this month with the same month a Maturity losing some or all of the original investment. year earlier. The length of time until the initial investment amount Total return Inflation-linked bonds/Index-linked bonds of a fixed income security is due to be repaid to the The term for the gain or loss derived from an investment Fixed income securities where both the value of the holder of the security. over a particular period. Total return includes income loan and the interest payments are adjusted in line Par value (in the form of interest or dividend payments) and with inflation over the life of the security. Also referred The initial price of a bond, also known as face value. capital gains. to as index-linked bonds. Treasuries Investment grade corporate bonds Principal Fixed income securities issued by the US government. Fixed income securities issued by a company with a The face value of a fixed income security, which is medium or high credit rating from a recognised credit the amount due back to the investor by the borrower Yield (bonds) rating agency. They are considered to be at lower risk when the security reaches the end of its life. This refers to the interest received from a fixed from default than those issued by companies with Retail Prices Index (RPI) income security and is usually expressed annually as a lower credit ratings. Default means that a company A UK inflation index that measures the rate of change percentage based on the investment’s cost, its current or government is unable to meet interest payments of prices for a basket of goods and services in the UK, market value or its face value. or repay the initial investment amount at the end of a including mortgage payments and council tax. security’s life. Z 14

spin-free guide to property Investing | Risk | Equities | Bonds | Property | Income

Contents What is commercial property? 3 The benefits of investing in commercial property 4 Property compared with other types of investments 5 Understanding how commercial property can rise or fall in value 6 How to invest in commercial property 7 Types of property fund 8 A few questions to ask before you invest in a property fund 9 Glossary 10 Spin-free guides 11 Please refer to the glossary found on page 10 for an explanation of the words highlighted in bold throughout this guide. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to a financial adviser. The views expressed in this document should not be taken as a recommendation, advice or forecast.

What is commercial Commercial property refers to buildings used by businesses. property? The three main types of commercial property are retail, office and industrial. You can also invest in several other areas, from hotels and health centres to cinemas. Commercial property in brief Who uses commercial property? Commercial property is part of our everyday lives, as Commercial property covers many different types of this asset class includes the places where we work, shop buildings, but there is arguably even more diversity and relax. in the types of occupiers. Virtually all industries and businesses use commercial property, varying from small There are three main types of commercial property: locally based companies to multinationals and even retail, office and industrial. governments. Retail property: This is the largest section of the commercial property market and consists of shops, shopping centres and retail parks, which contain a mix of retail outlets. Office property: This includes business parks as well as office buildings. Industrial property: This covers factories, distribution warehouses and industrial estates. 3

The benefits of Commercial property offers the prospect of a reliable income. investing in Over the long term, this is likely to make up most of the total return you may achieve. commercial You may also get some capital growth, as properties can rise in value. However, they may property also fall in value. The potential for income The potential for capital growth The main source of return from commercial property Commercial property also has the potential for capital investment is normally the rent paid by the tenants – growth, meaning that if the property were to be sold, over the long term, this is likely to make up most of the the investor may receive more than the purchase price. total returns you may achieve. Of course, the investor may receive less if the price were to fall. Rental payments are made on a regular basis as set out in the lease agreement, just as they are when people rent A feature of commercial property is that its value tends residential properties. However, commercial property to be largely based on the reliability of the regular has two big advantages over residential property. The rental income rather than the emotional decisions that leases tend to last much longer and there is usually a can sometimes affect stockmarkets. This is one of the better chance of the rent being paid, as businesses are reasons that the performance of commercial property generally more reliable tenants, with access to larger is normally less volatile than some other types of sums of money. investment. Leases on commercial property can be for five or ten years – sometimes even longer – which means a commercial property investment offers the scope for a predictable, regular income that lasts the life of the lease. What’s more, rental rates are normally reviewed every five years and, in many cases, the rent can only be revised upwards. 4

Property compared Cash savings are perceived to be the safest way to invest, but returns are not high. with other types of Property has the potential for greater total returns than bonds over the long term. However, it investments tends to have less growth potential than equities. Bonds offer the potential for a regular income and tend to be lower risk than equities but have less chance for strong growth. Equities (also known as shares) are higher risk than bonds, property and cash, but they also offer the most potential for strong growth. Costs associated with buying and selling properties are generally higher than those for equities and bonds. Should you choose property over Equities have the potential for strong growth, but also bonds or equities? come with the possibility for greater losses as their value When it comes to choosing where to invest, the option fluctuates more and there is no obligation to pay the you go for is likely to depend on how you feel about risk shareholder back the original amount they invested. and what you need from your investment. Property can also be an appealing way to increase the Bonds are generally lower risk than equities as there is level of diversification in a portfolio focused on equities an obligation to pay the bond holder back the original and bonds. This is because it tends to perform very amount they invested. Bonds provide a regular income differently when market or economic conditions change. with more growth potential than cash. Diversification is a useful way to reduce risk in a portfolio. Up to £75,000 of your money is secure in a bank or building society through the Financial Services Compensation Scheme, unlike stocks and shares or fixed interest investments which are less secure. Property offers the combination of a stable, long-term income and potential for some growth. 5

Understanding how Commercial property is affected by supply and demand. commercial property Location and quality are also important. can rise or fall A tenant that defaults (in other words, doesn’t pay their rent) can significantly affect in value your returns. There are four key factors that affect the performance Location and quality of a commercial property investment. The highest-quality buildings in the best locations (which Supply and demand are known as prime property) attract the highest rents. When the economy is doing well, businesses prosper and However, a property’s status can change. For example, a look to expand, which means they need more space. prime retail shop might be downgraded if it is not looked This extra demand means that tenants will be prepared after by its owner or if a new shopping centre up the to pay higher rent, which generally feeds through to road takes away some of its customers. higher property values. In contrast, a downturn means Of course, there can be positive changes as well, such as an businesses are likely to cut back on expansion plans or industrial property being turned into a retail warehouse, even reduce the number of people they employ. This can which normally means it can charge higher rents. depress rents and property values. The difficulty in buying and These effects are exaggerated by the time it takes to selling property build commercial property, as the construction of new Unlike many other types of investment, property is quite buildings often lags behind rising demand. Equally, when difficult to buy or sell. The process takes time and there demand falls away, the buildings are still there, so there is no guarantee either that buildings will be available may be more available than are needed. to buyers or that sellers will be able to find a buyer. (To The financial strength of the use the technical term, property is less ‘liquid’.) This can tenants mean that, if a property needs to be sold quickly, its If a tenant is financially strong, they are less likely to value can suffer. Also, buying property requires a large default, so rental income can be more secure. A longer initial investment. lease also means greater security for the owner. This is important because default is one of the key risks in property investing. After all, if a tenant goes bust, the rent stops being paid and the owner’s costs rise. 6

How to invest in You can buy commercial property yourself. commercial You can buy shares in companies in the property sector. property You can put your money into a fund that invests in property. Different ways you can invest Property funds: A fund manager invests your money in in commercial property commercial property on your behalf. This gives you the Direct: You can buy and manage commercial benefit of the fund manager’s experience and expertise, properties yourself, though it’s likely you will as well as the resources of the investment company need a significant sum to get started – and you they work for. Some property funds buy buildings and may be relying on the performance of just one or manage them (these are known as ‘bricks and mortar’ two buildings. funds), while others focus on property company shares. Property company shares: You can buy the shares If you are interested in commercial property for its of companies that own, manage or develop property. income potential or lower level of risk, you may need If they do well, their shares should rise in value. The to take care when choosing where to invest. Although companies may also pay a dividend to shareholders, property company shares are in a position to benefit which would provide you with an income. However, over from the income generated by the properties they hold, time, the returns from property company shares tend to in the shorter term, their returns are usually more like be more variable, or volatile, than a direct investment the performance of shares – which means they involve a in property. higher level of risk. If you’re not sure about the suitability of an investment, you should speak to a financial adviser. 7

Types of property There are several different legal structures that property funds can use, which affect how they are set up and how they are taxed. fund These include unit trusts, Real Estate Investment Trusts (REITs) and Property Authorised Investment Funds (PAIFs). Choosing the structure of Property Authorised Investment Funds your fund (PAIFs) This section of our guide explains some of the legal These are similar to unit trusts, but have a legal structure structures of property investment funds. This information that makes them more tax-efficient for certain investors. is important as there can be significant benefits in How PAIFs can give you more choosing a fund with the right structure for your needs, particularly if you plan to hold it in an Individual Savings for your money Account (ISA). Please note, ISA tax advantages depend ‘Bricks and mortar’ unit trusts have to pay 20% tax on on your individual circumstances and ISA tax rules may the income they receive from rent, which reduces the change in the future. amount they can pay to their investors. However, PAIFs Three types of fund leave tax payments to the investor. Property unit trusts This means that when a PAIF is held in an ISA (where you A property unit trust is simply a fund that invests in don’t have to pay tax on investment income), the income property, where the investors own a specified number from a ‘bricks and mortar’ PAIF can be considerably of units depending on how much money they have more than the income from a comparable unit trust. invested. The value of the units depends on the value of the properties in which the fund is invested. Real Estate Investment Trusts (also known as REITs) These are investment companies that own and manage property. This means they have a share price that can be different to the value of the properties they hold (as the price is affected by supply and demand). They must pay out at least 90% of the taxable income they receive to investors in the form of dividends. 8

A few questions to Is there a range of property types in the fund? ask before you invest Does the fund have some cash reserves? in a property How does the fund manager plan to increase the value of their holdings? fund Does the fund manager’s company have the necessary resources? Does the fund meet your needs? Is it making the most of its properties? There are many property funds out there and their If most of a fund’s properties are occupied (in other names aren’t always that informative. However, you can words, it has a low vacancy rate) and its tenants are get an idea of the growth potential and risks by looking on longer leases, this means the fund is less likely to at the investments a fund makes and the company that experience a sudden drop in rental income. runs it. Equally, it’s good to check that the fund manager Where does the fund invest? is doing everything they can to maximise returns. A good place to start is to check how varied a fund’s For example, they could refurbish properties, change holdings are. This doesn’t just mean the number of planning use or improve their leases. properties it holds, it’s where they are located, what size Is the fund sensibly run? they are, how many tenants they have and what sectors they serve. When you put your savings in a property fund, you might expect all the money to be spent on buying properties – A broad spread of properties means a fund can cope after all, that is the point of the investment. However, a much better with a downturn in any one area – and well-run fund should hold some cash in reserve, so it is having lots of tenants means you aren’t relying on the ready to take advantage of new opportunities and can fortunes of just a few businesses. easily meet any withdrawals. What about the fund’s size and resources? At the most basic level, a larger fund is able to buy bigger properties – so it has more options to choose from. However, a well-resourced and highly experienced team also has more market knowledge and better access to opportunities. 9

Glossary Investment terms The following are explanations of some of the terms you would have come across in this guide. Asset Diversification Prime property Anything having commercial or exchange value that The practice of investing in a variety of assets. This A prime property is likely to be finished to a high Ais owned by a business, institution or individual. is a risk management technique where, in a well- standard, have a commercially attractive location Asset class diversified portfolio, any loss from an individual and be let to a financially sound tenant. Category of assets, such as cash, equities (or holding should be offset by gains in other holdings, Risk company shares), fixed income securities and their thereby lessening the impact on the overall portfolio. The chance that an investment’s return will be sub-categories, as well as tangible assets such as Dividend different to what is expected. Risk includes the real estate. Dividends represent a share in the profits of a possibility of losing some or all of the original Bond company and are paid out to the company’s investment. A loan in the form of a security, usually issued by shareholders at set times of the year. Total return a government or company, which normally pays a Equities The term for the gain or loss derived from an fixed rate of interest over a given time period, at the Shares of ownership in a company. investment over a particular period. Total return end of which the initial amount borrowed is repaid. Lease includes income (in the form of interest or dividend Capital growth A contract between a landlord and a tenant. It sets payments) and capital gains. Occurs when the current value of an investment is out the terms for the tenant to occupy the property. Volatile greater than the initial amount invested. Liquid When the value of a particular share, market or Commercial property A company is considered highly liquid if it has plenty sector swings up and down fairly frequently and/or Any property that is used for business purposes. The of cash at its disposal. A company’s shares are significantly, it is considered volatile. three main sectors are retail, industrial and offices. considered highly liquid if they can be easily bought Default or sold since large amounts are regularly traded. Z When a borrower does not maintain interest payments or repay the amount borrowed when due. 10

spin-free guide to income Investing | Risk | Equities | Bonds | Property | Income

Contents Understanding the income challenges facing investors today 3 Risk and reward 4 Income from equities 6 Income from fixed income 8 Understanding bond yields 9 Income from commercial property 10 Things to consider 11 Glossary 13 Spin-free guides 15 Please refer to the glossary found on pages 13 and 14 for an explanation of the words highlighted in bold throughout this guide. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to a financial adviser. The views expressed in this document should not be taken as a recommendation, advice or forecast.

Understanding the income challenges facing investors today A difficult environment for income investors Low interest rates and several longer term factors make It is particularly important to remember that if the it hard to get an income from cash income you receive on your savings does not keep pace with the rising cost of living (ie the inflation rate), your If income doesn’t keep pace with inflation, your purchasing power will reduce over time. In other words, purchasing power falls over the years your money will buy you less of the same goods in the You may need to explore other investment options to future than it can today. achieve the income you need Taking all this into account, individuals are recognising The legacy of the global financial crisis has made life the need to put cash to work to generate a better level difficult for savers. Across much of the developed world, of income from alternative sources. policymakers, such as central bankers and politicians, In this guide, we outline some of these options for have looked to revive economies with historically low generating income. interest rates. This means keeping cash in the bank has generally paid very little reward. As such, drawing an Please remember that up to £75,000 of your money income from savings alone may no longer be sufficient is secure in a bank or building society through the for many people to maintain the lifestyle they expect. Financial Services Compensation Scheme, unlike stocks and shares or fixed interest investments which are less secure. 3

Risk and What is risk and reward? When it comes to investing for income, it is important to review your reward attitude to risk versus reward. Risk reflects the chance your investments could fall in value More risk normally means more potential for growth or income If you choose a low-risk investment, the initial sum invested is not expected to grow very much. But if you choose a higher risk investment, your initial sum could grow or reduce considerably. It is also important to keep a sufficient level of cash available for short- term needs and to fully understand the potential risks involved in investing. No financial asset is always either ‘risky’ or ‘safe’ and the risk/reward characteristics of different assets will change depending on the length of time over which you wish to invest. Levels of risk While there are varying levels of income available across the different asset classes, it is worth bearing in mind that investing in assets that pay higher levels of income can increase the risk of capital loss. This is because higher levels of income are often available as ‘compensation’ for taking on greater risk. Before choosing a particular income strategy, it is essential that investors are comfortable with the level of risk involved. Risk is the possibility of losing some, or all, of your capital (your original investment). Risk refers to uncertainty. All investments carry a level of risk. 4

Risk and Two ways to generate an income are by investing in equities, that is, company shares, or in bonds where you lend money to a government or company. Both involve more risk than keeping your money in cash. If a company does well reward continued and is profitable, equity holders usually receive a share of the profits in the form of a dividend. If the company does not do well, shares may fall in value. Bond holders expect regular interest payments and for the loan to be repaid to them at the end of the fixed term. However, there is a risk a borrower might get into financial trouble and be unable to pay interest or repay its loan. An income strategy One way to make decisions about income investing is to ask yourself three simple questions: What level of income do I need? How often do I need to be paid? How much risk am I willing to take on to achieve the income I want? Investing with an expert Rather than managing your own investment portfolio, you may choose to invest in a fund. A fund is an investment vehicle where the money of many investors is pooled to buy a portfolio of equities, bonds or other assets – which is managed by a professional fund manager – to achieve a particular investment objective. Some funds pay income to their investors in the form of distributions. The value of investments will fluctuate, which will cause fund prices to fall as well as rise and you may not get back the original amount you invested. 5

When you buy a share, you become part owner of a business Income from Some businesses share their profits with their owners in the form of dividends equities If a company does well, its dividends tend to grow over time, but there is never a guarantee dividends will be paid Equities are issued by companies aiming to raise money A share of the profits by offering a share of ownership in the company Dividends are a share in the profits of the company paid to investors. The most common way of investing in to shareholders and will vary depending on the company’s equities is by buying shares of companies listed on a business strategy and how well it is doing. The directors stock exchange. of the company will decide how much profit – if any – is For growth and for income to be paid out in the form of a dividend to shareholders, and how much profit should be reinvested in the company The value of shares will fluctuate depending on how to drive future growth. much investors are willing to pay for them at different times. This is affected by a number of factors, such as the past fortunes of the company, perceived prospects for the business, broader economic trends or simply investor sentiment. Investors make money in shares by selling them for more than they bought them for. In this way, equities can provide capital growth. It is also possible to generate income from equities in the form of dividends. 6

Income from equities continued The potential to rise over time can go up or down and unexpected factors can affect a An attractive feature of financially stable companies’ company’s ability to pay dividends. One approach is to dividends is that they tend to grow over time. Firms often spread risk by investing in many different companies at attach great importance to increasing their payout to once. For some people, the most efficient way of doing shareholders. This is known as a progressive dividend this is through investing in a fund. policy. If a company is able to grow its dividend over Investing for dividends time, there is potential for its shares to deliver a rising income stream, which may help offset the effects of If you hold company shares directly, any dividends will inflation. Furthermore, dividend growth is often viewed be paid to you as the shareholder, but if you’ve invested as a measure of a company’s long-term strength, which in equities through a fund, the dividends are paid to the is also an important consideration for those seeking fund. The fund may pass dividends on to investors in the capital growth. form of distributions. Before investing, you should find out whether a fund makes distribution payments and if they The risk of losing money do, how frequently they are paid. Making a call on the right companies to hold for capital The value of investments will fluctuate, which will cause growth and income can be complicated and risky. Share fund prices to fall as well as rise and you may not get prices – and, therefore, the value of your investment – back the original amount you invested. 7

When you invest in bonds, you lend money to governments Income from fixed and companies They agree to pay you interest, plus the original amount back at the income end of the loan This means there is the potential for a stable income, but the borrower may fail to keep up with repayments Fixed income, or bond, investments are loans made The chance of a loss by investors to governments (government bonds) or While income payments are fixed, the price of the bond companies (corporate bonds) seeking to raise money can go up or down as bonds are traded in the marketplace, by issuing debt securities. The borrower makes interest although over the long term, prices tend not to fluctuate payments to the investors in the form of ‘coupons’, as much as company share prices. Therefore, it is possible and pays the original investment back at the end of the to make a profit on a bond and achieve some capital term of the loan (‘maturity’), which can vary from a few growth. However, it is also possible to make a loss. Because months to many years. bond prices can move, the value of your investment can What is a coupon? also change as the return on the bond (also referred to as Coupon payments mean that you could receive a stable, the yield) can vary. regular income. If the coupon is fixed, you will generally know the exact amount of income you will receive, and when it will be paid. This can make it easier to plan ahead. Income: coupons Fixed coupon investments offer little scope for income You often know exactly how growth, however, and may not have the potential to keep much you will receive, assuming pace with inflation. Some bonds are index-linked, which the issuer doesn’t miss payments. means the coupon will be adjusted over time to provide some protection for your income against inflation. Capital return Different levels of risk If you buy a bond from another It is important to remember that bonds are not ‘risk-free’. investor for less than its original There is always the risk that the government or company cost, you could make a profit by you have lent to will fail to keep up with payments. The holding it to maturity. higher the perceived potential for this to happen, the higher the income payment you will usually be offered. 8

However, even the supposedly ‘safest’ bonds can Understanding experience meaningful price movements as factors such as interest rates and inflation have a significant bond yields impact on prices. Corporate bonds Corporate bonds generally offer a higher income than government bonds as they are perceived to be riskier investments. However, there is, as with government Bond coupons and bond yields are two different things. bonds, also a hierarchy of risk/return potential within Coupons are usually fixed, while yields vary. The yield the corporate bond sector. Investors can identify those is calculated by dividing the coupon by the price of the firms that present potentially greater credit risk by bond, and since prices can move, yields also change. the credit ratings given to companies by independent For example, if the UK government issues a bond at £100 ratings agencies. with a 5% coupon, the coupon payment will always be Investment grade bonds are issued by firms that £5. At issue price, or ‘par value’, the yield is also 5%. If are believed to be in a comparatively stable financial the price of the bond falls to £90, the coupon is still £5, but position. These bonds are generally considered to be the yield rises to 5.5%. On the other hand, if the price rises relatively safe investments with less credit risk, and to £110, the coupon is still £5, but the yield falls to 4.5%. therefore have a higher credit rating and usually offer a This is why, if you need a certain level of income, the price lower level of income. you pay for a bond is important as well as the coupon. High yield bonds are issued by firms that are perceived Government bonds to have low credit quality. They are so-called because Government bonds are generally considered some of the they offer particularly high levels of income due to the safest types of investment. However, the risk and reward fact that they are believed to be less financially secure. potential of government bonds varies across issuing Investors who are willing to lend money to these riskier countries according to the stability of their governments companies may be offered very attractive real returns. and economies. Investors should be able to identify those The high yields are offered in part to compensate governments that present potentially greater credit investors for the potentially greater risk that these risk by looking at the credit ratings given to different issuers may not make their interest payments or repay countries by independent credit ratings agencies. their loans. Governments that are considered to have a low chance of default (inability to make interest payments or repay The value of investments will fluctuate, which the initial loan) will generally offer lower levels of income will cause fund prices to fall as well as rise and from their bonds than those where the chance of default you may not get back the original amount is believed to be higher. you invested. 9

Commercial property offers the scope for capital growth and an Income from income from rental payments commercial It is normally seen as less risky than shares, but more risky than bonds property Commercial property is a term for the buildings that are Tenants and leases used for business, such as offices, warehouses and shops. Commercial property is generally rented out to a tenant Because of the required size of investment needed to buy who holds a lease on the property for a fixed period of commercial property, most people will only invest in this time. The lease will have a pre-agreed end date and asset class by buying shares in companies that own and a rent which will be paid on a regular basis, providing manage property or through investing in a property fund. a predictable, regular income for the term of the lease. A fund may own shares in property companies and/or Rents are generally reviewed every five years and are invest directly in physical ‘bricks and mortar’ property. usually only revised upwards. Income focused One risk to be particularly aware of is that property tends While it is possible to achieve capital growth through to be more difficult to sell quickly than shares or bonds. property investment (in other words, if the property were Therefore, you may not be able to sell out of a property sold for more than the amount it cost to buy), property fund as easily as other types of fund. income tends to be the key driver of overall returns. The value of investments will fluctuate, which will cause Of course, capital loss is also a possibility if the value of fund prices to fall as well as rise and you may not get back the property falls. the original amount you invested. 10

Things to consider While cash deposits may provide security of your money, risk-free. Capital loss can occur, particularly in a volatile or capital*, as well as instant access, income from cash interest rate environment. It is important to remember will fluctuate according to interest rates. In low interest that there is a hierarchy or risk/return potential within the rate environments, cash may provide very little income. asset class, according to the perceived creditworthiness This can be especially detrimental to purchasing power if of the issuer – in other words, how likely it may be to the rate of inflation is higher than interest rates, as your default on the loan. Also, while the amount of income capital will be growing more slowly than the price of the payable is fixed by the coupon, the value of the income goods you wish to buy with it. (the yield) will fluctuate as bond prices go up and down in the marketplace. Higher levels of income may be available to those willing to invest in other financial assets. However, using cash Considering commercial property to buy other assets that may potentially generate higher Commercial property offers the potential for both income income will mean taking more risk. growth (through rent reviews) and long-term capital Considering equities growth (through rising valuation of the property). However, there is also potential for capital loss, and although the Equities offer the potential for rising income over income stream could be fairly stable due to regular, fixed time through dividend growth. However, income is not rent payments, it is not guaranteed. The length of time guaranteed and equity prices can fluctuate considerably that can be involved in buying and selling properties in the short term. This means that, although there is makes this a less flexible asset class than equities and potential for significant capital gain, equity investors bonds, in terms of access to your capital. must think carefully about their time horizons and capacity for capital loss. *Up to £75,000 of your money is secure in a bank or building Considering bonds society through the Financial Services Compensation Scheme, unlike stocks and shares or fixed interest investments which are Fixed income securities or bonds, typically offer less less secure. potential for income growth than equities, but more certainty and regularity in terms of knowing the amount of income you should receive. However, bonds are not 11

Things to consider continued The value of diversification Consider your individual needs One well-established way of trying to manage investment Achieving the right combination of investments will risk is diversification. This is achieved by investing in require careful consideration of the characteristics that a blend of asset types that offer diverse characteristics different assets may offer, in the context of your individual and have the potential to behave differently in various circumstances. Investors need to think about whether economic or financial market environments. The essential they need a guaranteed income or if they are able to take principal of diversification is to avoid ‘putting all your some risk with their capital to aim for higher income. eggs in one basket’. This may provide the best chance of Important information generating a sustainable income stream for the long term. We are unable to give financial advice. If you are unsure The risk/return trade-off about the suitability of your investment, speak to your Achieving the right diversified blend for your needs will financial adviser. The views expressed in this document require careful consideration of the characteristics that should not be taken as a recommendation, advice different assets may offer, in the context of your individual or forecast. circumstances. Investors need to think about whether they need a guaranteed income or if they are able to take The value of investments will fluctuate, which will cause some risk with their capital to aim for higher income. The fund prices to fall as well as rise and you may not get back typical trade-off between higher return and higher risk is the original amount you invested. a basic principle of investing and should always be borne in mind. A diversified portfolio could be more stable as the You should also think about what you need the income market rises and falls. Combining bonds, equities and for, and over what time horizon. Different financial goals property may reduce the impact of shocks. will require different types of income stream. You may want to aim for steady, regular income or it might be more appropriate to try and achieve income growth over time. If you are unsure about the most appropriate way of generating income for your needs, please speak to a financial adviser. 12

Glossary Investment terms The following are explanations of some of the terms you would have come across in this guide. Asset governments as they are often considered more risky. Diversification Anything having commercial or exchange value that Coupon The practice of investing in a variety of assets. Ais owned by a business, institution or individual. The interest paid by the government or company This is a risk management technique where, in a that has raised a loan by selling bonds. well-diversified portfolio, any loss from an individual Asset class holding should be offset by gains in other holdings, Category of assets, such as cash, company shares, Credit rating thereby lessening the impact on the overall portfolio. fixed income securities and their sub-categories, as An independent assessment of a borrower’s ability well as tangible assets such as property. to repay its debts. A high rating indicates that the Defaulted/Default Bond credit rating agency considers the issuer to be at low When a borrower does not maintain interest A loan in the form of a security, usually issued by risk of default; likewise, a low rating indicates high payments or repay the amount borrowed when due. a government or company, which normally pays a risk of default. Standard & Poor’s, Fitch and Moody’s Distribution fixed rate of interest over a given time period, at the are the three most prominent credit rating agencies. Refers to the periodical paying-out of interest or end of which the initial amount borrowed is repaid. Default means that a company or government is dividends received by funds to their shareholders. unable to meet interest payments or repay the initial Capital investment amount at the end of a security’s life. Dividends represent a share in the profits of a Refers to the financial assets, or resources, that a company and are paid out to the owners of company company has to fund its business operations. Credit rating agency shares at certain times during the year. A company that analyses the financial strength of Capital growth issuers of fixed income securities and attaches a Dividend Occurs when the current value of an investment is rating to their debt. Examples include Standard & Dividends represent a share in the profits of greater than the initial amount invested. Poor’s and Moody’s. the company and are paid out to a company’s shareholders at set times of the year. Corporate bonds Credit risk Fixed income securities issued by a company. They can Risk that a financial obligation will not be paid and a Equities offer higher interest payments than bonds issued by loss will result for the lender. Shares of ownership in a company. continued on next page 13

Glossary continued Fixed income security/securities Inflation Risk A loan in the form of a security, usually issued by a The rate of increase in the cost of living. Inflation is The chance that an investment’s return will be different government or company, which normally pays a fixed usually quoted as an annual percentage, comparing to what is expected. Risk includes the possibility of rate of interest over a given time period, at the end of the average price this month with the same month a losing some or all of the original investment. which the initial amount borrowed is repaid. year earlier. Yield (income) Government bonds Investment grade bonds Refers to the income received from an investment and Fixed income securities issued by governments, that Fixed income securities issued by a company with a is usually expressed annually as a percentage based normally pay a fixed rate of interest over a given time medium or high credit rating from a recognised credit on the investment’s cost, its current market value or period, at the end of which the initial investment rating agency. They are considered to be at lower risk face value. is repaid. from default than those issued by companies with lower credit ratings. Default means that a company High yield bonds or government is unable to meet interest payments or Z Fixed income securities issued by companies with a low repay the initial investment amount at the end of a credit rating from a recognised credit rating agency. security’s life. They are considered to be at higher risk of default than better quality, ie higher-rated fixed income securities Maturity but have the potential for higher rewards. Default The length of time until the initial investment amount means that a company or government is unable to of a fixed income security is due to be repaid to the meet interest payments or repay the initial investment holder of the security. amount at the end of a security’s life. 14