There is a wide spectrum of investment vehicles available to modern investors. This gives individuals and companies a lot of scope when devising a strategy to hit their investing goals.
What are investment vehicles?
Investment vehicles are simply financial products investors use to make money. There are a variety of different categories available that balance an investor’s preferences when it comes to risk and reward.
Investment vehicles can be split into two categories: direct and indirect.
- Direct investments are ones where the investor has 100% control over which assets to buy (such as stocks and bonds). In this case, someone like a fund manager isn’t there to supervise which individual investments to buy.
- Indirect investment vehicles don’t give an investor control over which particular assets to hold. This is where there’s likely to be someone else managing the individual investments.
Types of investment vehicles
Let’s break down some of the different types of investment vehicles.
Unit trusts, OEICs, ETFs, and investment trusts
Unit trusts, OEICs, ETFs, and investment trusts are all types of funds that predominantly invest in shares.
Some of them may invest in a particular industry, country or region, while others may cover the whole globe. They are also responsible for most of the colourful adverts in the weekend papers. These are the most flexible type of product, allowing you to get your money out at any time.
The charges for ETFs and investment trusts tend to be lower so, given the choice, we prefer them over unit trusts or OEICs.
Pensions
A pension is basically a tax-efficient method of investing in shares, bonds, property, and cash. You get tax relief on money you invest in a pension, but there is a catch. In fact, there are three of them.
- You generally can’t touch your money until you are at least 55.
- Even though it’s no longer compulsory, you may have to use your money to buy an annuity, which means you give up your capital in return for regular income.
- The rules regarding pensions keep on changing, making it more difficult to know where you stand.
A pension is usually seen as the standard way to save for your retirement. In reality, it is just one of the options. Unfortunately, their obscure nature and inflexibility means that the charges on them tend to be quite high.
Structured products
Structured products have been growing in popularity in recent years. They often last for a fixed period, like five or seven years, and their value is linked to a stock market index, like the FTSE 100. They usually offer to limit your downside, with a guarantee that you will at least get your money back after the fixed investment period has ended.
What’s the catch, you might ask? Well, although these funds can limit any losses, your potential for gains also tends to much more limited than with a direct investment in the stock market.
In short, we’re not fans.
With-profits and endowment policies
These products have been much criticised in recent years. And rightly so. As a new investor, you’re far less likely to be offered one these days, because they have fallen so much out of favour. But we think they are worth mentioning, mostly as an illustration of how not to invest.
With-profits and endowments tend to be highly inflexible beasts that require you to commit to investing a regular amount over a long time. While that’s no bad thing in itself, if you do not manage to keep up the payments for some reason, you can end up paying heavy penalties as a result, and these can significantly reduce any returns you make.
These products tend to be ‘sold’ rather than being bought. Like pensions, their inflexibility and lack of transparency means they often boast high charges.
With-profit bonds attempt to smooth out the return of the stock market by awarding annual bonuses that cannot be taken away. But the largest bonus is kept right until the end and many people don’t get that far.
In short, best avoided.
A note on ISAs
An individual savings account (ISA) is a tax-efficient investment account. It isn’t an investment vehicle, but it is a popular tool that investors use to buy direct investments like cash, stocks, or a fund like an investment trust.
There are two types of ISAs available to investors:
- Cash ISA, which is basically a bog-standard savings account
- Stocks and Shares ISA, an investment vehicle in which an individual can buy a variety of assets like stocks, bonds, exchange-traded funds (ETFs), and investment trusts
Like you, we quite like paying less tax. So there’s a good chance that whatever we decide makes a good first investment, we’ll want to protect it in a tax-free ISA. Under current rules, individuals can invest up to £20,000 in a tax year in one of these products.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
What to consider when picking an investment vehicle
We think a first investment should be something simple, flexible, and low cost. Given the choices above, you can probably tell we’re leaning towards a fund, like an ETF or investment trust, probably within an ISA.
The long-term returns that the stock market can provide mean we’re big fans of investment vehicles that provide exposure to equities. The FTSE 100, for instance, provided a healthy average annual return of 7.8% between 1984 and 2019. That’s according to the number crunchers over at IG Group.
However, investing in shares is higher risk than buying something like a bond. It’s important to consider how much danger you want to expose your capital to when selecting investment vehicles. Someone with a low tolerance of risk might want to stay away from ones that are geared towards share investing, for example.
On the flip side, however, someone whose investment objective involves making market-beating returns might want to avoid investments like bonds that offer lower risk but also lower returns.
It may sound obvious, but having a decent level of knowledge is key when choosing investment vehicles. Legendary investor Warren Buffett said it best when he cautioned to “never invest in a business you cannot understand”. Going in half-blind and choosing a vehicle you don’t fully comprehend is about as risky as it gets.
We might have a preference for stock investing here at The Motley Fool. But we also believe in the importance of diversification whether you’re an experienced investor or one who’s just starting out. Holding more than one type of investment can spread the risk and provide an investor’s portfolio with added robustness over the long term.