What to consider when investing

What's your attitude to risk?

Your attitude to risk is a very personal and emotional thing. But when it comes to investing, it pays to be objective, too, and think about how much risk you are prepared to take.

As a general rule, the longer you have to invest, the more risk you can afford to take. So, just as a 20-something shouldn't be using a cash Isa to save for retirement, nor should somebody approaching their retirement be piling all their money into small technology stocks.

If you're more used to savings accounts that pay a pre-agreed rate of interest, paying money into an investment that could potentially see you lose money can be daunting. But this needs to balanced out against the risks of leaving your money in a savings account where it's highly likely it will lose value in real terms as its buying power is reduced by inflation. For many cautious investors, not taking enough risk becomes a very risky strategy to employ. You may not lose money but you may not make enough to achieve your financial goals.

By the same token, some adrenalin-junkie investors may need to tame their strategy in the final years of their investment when their priorities should shift from capital growth to capital appreciation.

What asset classes should I invest in?

Risk is an inherent part of investing but it is possible for cautious and balanced investors to control that risk by spreading their money across a variety of asset classes. This means that if one area is not performing well, the overall performance of your portfolio shouldn’t suffer.

What asset classes should you consider?

Cash: Cash on deposit should be the starting point for every investor - aim to have three to six months' expenses in an instant-access account for emergencies. Longer-term cash holdings can be held in fixed-term accounts spanning from one year to five or more. Typically the longer you can tie your money up for, the better the interest rate you’ll get.

Cash is the lowest-risk asset class, in so far as you are paid a pre-agreed rate of interest and you won't physically lose any money. It is also protected in case your bank goes under, thanks to the Financial Services Compensation Scheme (to the tune of £85,000 per person, per financial institution).

However, there is a big "but" - interest rates are at rock-bottom and are likely to remain low for some time. This means it's hard - if not impossible - for your money to keep pace with inflation and so over time its spending power will reduce. So while cash might be perceived as safe, it's not a risk-free investment.

Bonds and gilts (aka fixed-interest securities): Moving up the risk spectrum, we come to fixed-interest securities - these are essentially loans or IOUs made by investors in return for a fixed rate of interest. Loans to companies are known as corporate bonds while loans to governments are known as gilts or government bonds.

The risk is that the organisation receiving the loan may default on repayments. This means that the greater the risk of default, the higher the rate of interest you'll receive. While bonds are typically regarded as higher risk than cash and lower risk than stocks and shares, there is a huge variance of risk within the market.

Gilts are considered the lowest risk – as a government is unlikely to default. Within corporate bonds you can opt for safer investment-grade bonds or riskier, but better paying, high-yield bonds where there is a greater risk of default.

Property: Providing the opportunity for income and capital growth, property has the potential to be a lucrative investment. And because its performance is not linked to the stockmarket, it can be a great diversifier. Some investors choose to buy residential property to let out - an investment known as buy to let. But it can be expensive to buy and costly and hard to manage.

Commercial property investments can be easier to access - funds exist that specialise in the sector, buying up a portfolio of properties including industrial, retail, office and entertainment spaces; and the rent paid by the tenants provides a reliable income stream for investors. Leases are also much longer than those on residential properties, reducing risk and increasing stability for investors.

Stocks and shares: When you purchase shares, you are literally buying a stake in a company listed on the stockmarket. You also get shareholder rights, including the ability to vote at annual general meetings. The value of the share will rise and fall in line with the fortunes of the company in question. The price of the share will be influenced not just by the physical value of the company but by sentiment, too.

Prices tend to rise on the expectation of good news and fall on the publication of bad news. In addition to growth in the share price, investors may also enjoy an income stream in the form of dividends – which is the distribution of profits among shareholders. Share- or equity-based investments are regarded as the highest risk asset class, although of course some shares will be riskier than others.

Asset allocation

Just how much money you invest in each area will depend on your attitude to risk. Cash and fixed interest are at the lower end of the risk spectrum, so cautious investors may want to keep more of their money in these asset classes, while those who can afford to take more risk should be favouring stocks and shares.

Why funds are better than shares

It is possible to buy shares in individual companies directly in order to get equity exposure, just as it is possible to buy individual corporate bonds and gilts. You can also get your property fix by purchasing a house. But this approach is high risk and expensive.

Not only would you have to do an enormous amount of research to pick the most appropriate investments for you but it would be all too easy to place all your eggs in one basket. You'd also need to invest a huge sum to build a sufficiently balanced portfolio. All of the individual dealing charges would also make your portfolio incredibly expensive. With property, the costs of purchasing and managing your holding could be particularly prohibitive.

The easy and affordable way to invest in all of these asset classes is via a collective fund. The most popular type is a unit trust or open-ended investment company (OEIC). Here, your money is pooled with that of other investors and investments are bought and sold on your behalf by a fund manager in line with the objectives and risk profile of the fund in question.

With such a large amount of money to invest, the manager will be able to buy a lot more holdings than you would be able to (there could be up to 100 companies held in a fund), providing instant diversification and reducing your risk. Costs are shared with your fellow investors. You can sell your units whenever you like but, from a risk point of view, you should be invested for the long term.

You pay for this service via the fund's annual management charge. Prior to the abolition of commission payments to the companies, these averaged around 1.5% of the value of your investment but now they should be closer to 0.75%. Equity funds will buy stocks and shares in companies, while bond funds will invest in corporate bonds from a variety of firms and/or gilts (government bonds).

Commercial property funds will either buy property direct - typically, offices, industrial estates and retail space - with your returns being driven by the rents the manager achieves on those holdings; or will be invested in property-related companies, with your returns linked to the growth in those firms. Some funds invest across the asset classes and are known as mixed investment funds.

What's the cheapest way to buy funds?

Unlike savings accounts, you have to pay to invest in funds. However, if you know where to look, it is possible to cut the cost of investing and keep more of your returns. Ironically, buying direct from investment managers is the most expensive route – with most of them levying an initial fee of 5%.

However, investment platforms - also known as fund supermarkets - which allow you to buy funds from across the investment universe will waive this fee. As well as being cheaper, these platforms are also more convenient because they allow you to hold all of your investments in one place, making your portfolio easier to manage and review.

And if you're not sure where or what you want to invest in, they include lots of tools to help you choose the most appropriate funds. Some even provide model portfolios for investors that do not want to make the decision themselves. Investments can be held within an Isa if you are looking to save on tax or a SIPP (self-invested personal pension) if they are pension savings.

While these services do allow you to cut the cost of investing, they are not free. Until recently, many had no upfront charges, making them appear free but the platforms had been earning a trail commission on the back of all the funds they sold - money that was being paid by investors as part of their fund's annual management charge or AMC. The regulator did not like this approach and through what is known as the Retail Distribution Review banned the payment of commission.

As a result, since April, all platforms have had to introduce a new upfront charging system, which, the Financial Conduct Authority hopes, will make it easier for investors to compare costs. At the moment, the market is split between platforms that charge a fixed fee and those that charge a percentage of your holdings. Many are moving towards the sale of so-called "clean" shares for funds where there is a lower AMC that doesn't include any commission payments but where retail or "dirty" shares are sold, the commission element of the AMC will have to be rebated back to the investor.