Which investment types are right for you? (part-1)
Intro
There are many different investment types, as you may have realized by now: shares, commodities, funds, bonds, cash, foreign currencies, and the list goes on.
Let’s take a moment to consider the benefits and drawbacks of investing in company shares and investment funds, as well as other forms of trading such as CFDs and Spread Bets.
Stocks
Company shares can go up or down, depending on the general market sentiment, and on the company specifics. When a market is generally moving higher, it is commonly called a ‘bull market’. When prices are going down generally, investors call it a ‘bear market’.
PROS
- You choose the precise firm you wish to invest in. Since every company has a different risk and reward profile, you should conduct research and make investment plans for businesses you anticipate will expand.
- There are two possible ways to earn investment returns: a rising share price and dividend payments, which are payments made to shareholders from a company’s profits but are never guaranteed.
- Investing in shares of a specific company may involve a higher degree of risk than a portfolio consisting of a wide selection of shares, including an investment fund, but may also offer a higher potential return.
- Investment gains are subject to capital gains tax (CGT). In some markets, like the UK, shareholder returns up to a specific threshold may be tax-free, and accounts like ISAs can offer further tax benefits. It’s important to learn about CGT and tax-efficient savings in the country or area where you currently live.
CONS
- If you choose a non-performing business, you risk receiving minimal profits, having your investment lose value, or even losing everything if the business fails. Before making an investment, you must be aware of and comfortable with the level of risk.
Investment Funds
With the help of investment funds, individual investors can purchase a variety of assets simultaneously. They pool together money from several investors and utilize them to purchase a variety of investment instruments. This may consist of shares listed in various markets around the globe, bonds, cash, and other investment categories.
Funds may be actively managed, meaning that a fund manager is in charge of purchasing and disposing of assets with the goal of outperforming a particular benchmark, such as the FTSE 100. On other hand, passively managed investment funds, may have a mandate to simply mirror a particular index or benchmark.
PROS
- A qualified manager chooses which assets are purchased or sold inside the fund. Less experienced investors, or those who do not have the time to personally manage their investment portfolios or make their own investment decisions, may choose to invest through purchasing units of an investment fund, since fund managers are better equipped to react to changes in the market.
- Since the risk is distributed across a large number of underlying investments, investment funds normally carry less risk than individual shares, even though their value may still decline.
- Regular contributions can assist lower the average entry price you pay for the underlying investments (or “average down” your cost of investment), if you make regular contributions across time, for example on a monthly basis. However, there are no guarantees.
CONS
- The services of fund managers are compensated. Typically, a management and an administration fee are charged, which are defined as a percentage of the amount invested.
- Investing in a handful of companies, would yield a higher return if these prove to be successful and profitable, compared to a less risky portfolio with a wide spread of investments.
- Like any investments, there is a chance that you could lose your original amount invested.
CFDs and Spread Betting Instruments
In some ways, Spread Betting and CFD trading have similarities with stock trading. Like shares, Spread Betting and CFD trading, involve two prices, the BID price (Buying price) and the ASK price (Selling price). The difference between these two prices is known as the spread.
However, CFDs (“Contracts for Differences”) are complex instruments that allow traders and investors an opportunity to speculate on the price movement of an asset, without owning the underlying assets. This is accomplished through a contract agreed between an investor and the broker to exchange the value of a financial instrument between the opening of a contract and the close, without utilising a physical asset such as a shares, forex, commodity, or futures exchange.
With Spread Betting, there is an additional element to the trade that the investor must consider, which is the “stake” size. For example, if an investor stakes an amount of £10 for each point in price difference, this means his total profit is the number of points multiplied by the stake amount.
Trading in CFDs and Spread Bets, offers several major advantages that have increased the instruments’ enormous popularity in the past decade, but also has additional risks associated with leverage.
A key difference between more traditional investing and Spread Betting or CFD trading is that you can make money from both rising and declining values of various investments across financial markets.
In general, unless you’re deliberately trying to “short” a stock, you’ll buy investments with the goal being to bag a profitable sell price if the value rises.
Meanwhile, with CFDs and Spread Bets, you can trade on what’s called the “long” or “short” side.
Trading on the long side means that you’re putting your money in with the expectation that the sell price will rise.
By contrast, trading on the short side means that you’re expecting the sell price to fall, and so you’ve closed your position to cash in on a decrease in value.
It’s remarkably challenging to profit from trading in periods of declining financial markets, so the fact that trading CFDs and Spread Bets allows to short them, is one strong benefit of them as a product.
PROS
- Access to the underlying asset at a lower cost than buying the asset outright, CFDs allow you to trade expensive investments that you otherwise might not be able to.
- This also typically means you’ll pay less in fees, especially if these are calculated as a percentage of your investment.
- Ease of execution
- Ability to go long or short. With CFDs and Spread Bets, you can ‘go long’ when you BUY, and ‘go short’ when you SELL.
- Access to leverage, which is a form of credit or borrowing that the broker grants to the trader, allowing a greater buying power and enabling the trader to gain a large exposure to a financial asset using a fraction of their trading capital known as a margin. This increases potential gains, but also potential losses.
- Investing in different financial markets and assets like these can increase your ability to create a diversified portfolio.
- Furthermore, the fact that potential gains made on Spread Betting are tax-free for investors residing in the UK, makes Spread Bets an even more attractive investment option.
CONS
- There’s an immediate decrease of the investor’s initial position, which is reduced by the size of the spread upon entering the CFD or Spread Bet.
- The need to maintain an adequate capital balance (‘margin’) to cover for the granted leverage in case of potential losses.
- Leverage magnifies both profits and losses, and these may amount to your initial amount invested.
- Keeping daily funded Spread Bets or CFD trades open overnight, will result in funding charges, which are interest adjustments made to your account and reflect the cost of funding your open positions. Therefore, it is important to keep in mind these costs if you decide to hold CFD and Spread Betting positions for longer periods of time.
Key takeaway
As they help spread investment risk and eliminate the need to choose individual equities, investment funds might be a more prudent place to start. Compared to individual holding shares, they often provide steadier returns with fewer noticeable ups and downs, but also lesser potential gains or losses. On the other hand, CFD trading and Spread Betting, has become one of the most popular investment concepts in the past few years, with many investors starting to pursue it as an effective short-term trading alternative
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