Can understanding investment basics help you make clearer investment decisions?

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Making decisions about where to invest the money in your pension pot can seem daunting, but getting to grips with some straightforward investment basics can help you understand what you’re comfortable with.

Here’s a few pointers to help you get started…

The relationship between risk and reward

Riskier investments tend to have better long-term growth potential, but they can also experience greater falls in value from time to time. On the other hand, less risky investments tend to be more resilient to market falls.

It’s also important to remember that, if your savings grow at a slower rate than inflation, what you can buy with your savings – known as their spending power – will reduce.

In the end, it’s about finding the balance that’s right for you. A financial adviser can help you work out your appetite for risk, and risk questionnaires can help you think about what taking, or indeed avoiding, investment risk really means. Please be aware that inflation will reduce what you can purchase in the future and you may get less back than your original investment.

Diversification

Another investment term that’s often bandied around is diversification. But what does it mean?

Diversification means having a variety of investments, but it’s not just about having lots of investments for the sake of it. The point of diversification is that different types of investments can perform differently from each other. So if you hold a mix, when one type falls other types may rise and help counteract the impact of that loss.

By carefully spreading your pension pot between different investments you’ll reduce the risk of losing money on all of your savings at the same time.

How you spread out your investments is called asset allocation. It simply means how you decide to split up – or allocate – the money in your pension pot between the different investment options available. This can be as easy or as difficult as you choose. At the easy end of the spectrum are one-fund solutions which package a diversified mix of different types of investments into a single fund. Alternatively, you and your financial adviser could build your own portfolio by choosing the investments yourselves.

Types of investment

The three main types of investment are equities, bonds and cash. Equities are the shares that you can buy in publicly listed companies and historically they’ve delivered the best long-term returns. But they also carry the biggest risk of falling in value, particularly over short periods.

Bonds are loans made to either a company or a government. In return for lending them your money, the company or government commits to paying you interest as well as repaying the loan. You can either buy these bonds directly or through an investment fund. Bonds are generally less risky than equities, but tend to grow more slowly.

Cash is the term used for money that’s held on deposit as with a savings account and, although it’s very secure, it isn’t risk free. The main risk with holding money in cash is inflation. The interest earned on cash doesn’t always exceed the rate of inflation and so the value of your money might not keep up with the increasing cost of everyday things.

In addition to equities, bonds and cash, other investment types include property; commodities such as gold and oil; and specialist investments like fine wine or classic cars.

Making a choice

Where you decide to invest your pension savings and how much you put in to each type of investment will depend on a lot of things.

How long do you have until you would like to retire? What is your attitude to risk? Do you have other savings, such as ISAs, for example? What level of income will you need in retirement? A financial adviser can help you analyse all of these questions and work with you to create the most appropriate investment strategy to help you hit your retirement goals.

Ready-made fund solutions are one straightforward way to invest. Designed to offer whole investment strategies conveniently packaged into a single fund, these funds will change your asset allocation over time and will reflect your own appetite to risk and your changing circumstances as you get nearer to retirement age. Remember, the value of your investments may go down as well as up and you may get back less than you originally invested.

If you’re confident about making your own investment choices, you can create your own pension portfolio, either by yourself or through an adviser.

To make the most of the money in your pension pot and to come to investment decisions that match your attitude to risk, it’s essential you take advice if you’re in any way unsure of your options.

We recommend talking to a financial adviser if you require further guidance regarding investments.