There are many different assets in which you can invest. In this part of the website we outline the features of the three most common types of assets used in pension schemes:
You can also see a graph showing the returns achieved by these assets over the last 20 years.
We have also included information on property, an asset class that is becoming more popular as an investment within pension schemes.
Equities
An equity is another name for a company share. Buying shares in a company gives an investor a share of the ownership of that company and an entitlement to a share of its profits. The returns achieved on equities are made up of two parts: the portion of profits paid out to shareholders as income – called "dividends" – and the value of the share itself – the share price.
The shares of hundreds of companies are bought and sold on the London Stock Exchange, and on other exchanges around the world, every business day.
How risky are equities?
The prices of equities, and therefore their returns, fluctuate more than returns from other types of asset. These fluctuations – known as "volatility" – can occur for a number of reasons. For example, changes in economic conditions, changes in specific company factors, attitudes of investors and investors' perception of the quality of the company's management, assets, people and competitive position.
Bonds
A bond is basically an IOU issued by a government or a company that borrows money from investors. Under the terms of the IOU, the borrower promises to repay the lender (the holder of the bond) a specified amount on a specified date in the future and, until that date, the borrower pays a pre-determined rate of interest to the lender. Bonds can be "fixed interest" where the interest and capital repayment amounts are fixed, or "index linked", where the interest and capital repayment amounts are inflation-proofed.
A bond holder doesn't have to keep a bond until the date of its repayment. Bonds can be bought and sold at any time and this means that the value – or the price – of the bond itself fluctuates. The level of fluctuation depends on the demand from investors, the credit-worthiness of the issuer and on the current levels of interest rates available in the market.
How risky are bonds?</p>
Although the value of bonds does fluctuate, generally the promise of regular interest payments and repayment of the original investment on a specified date makes them a safer investment than equities. However, it's important to consider the credit-worthiness of the borrower – in other words, how good is the promise that the terms of the IOU will be met?
British Government bonds, because they are issued by Her Majesty's Government are considered to be more credit worthy than bonds issued by any other borrower in this country. These are known as "gilt-edged securities" or simply as "gilts". Most bonds issued by companies (called corporate bonds) are rated by credit-rating agencies that consider the likelihood of the company being able to meet the terms of the IOU. The lower the rating, the less likely the borrower is (in the views of the rating agency) to honour its promises both in terms of income generation and capital growth – and therefore the more risky the investment is likely to be.
Cash
We all know that you can invest in cash by depositing money in a bank or building society account. Investment managers also invest in cash through short-term money instruments that act in a similar way to a bank account.
How risky is cash?
Many people believe that a bank or building society is the safest place for their savings. Cash deposits are indeed a good way of saving over short periods, as you know your money will be relatively safe. But investing in cash is probably not the best strategy over the longer-term. This is because returns on cash deposits have historically been relatively low compared to inflation – so cash savings are unlikely to grow at a rate that would provide enough money for your retirement. However, past performance is not necessarily a guide to future performance.
How have these assets performed?
The chart below shows the returns from a broad spread of UK equities, UK government bonds and cash deposits over the last 25 years. We have assumed that an investment of £10,000 was made on 31 December 1981 and plotted the accumulated value of the investment, on a monthly basis, to 30 November 2006. We have allowed for the effects of price inflation – this means that, in terms of purchasing power, £10,000 in 1981 is worth the same as £10,000 in 2006. An accumulated value above £10,000 means that the investment has achieved a return ahead of inflation.
The chart shows that, over the last 25 years, the returns from UK equities have been better on average than those from UK government bonds and cash. If you had invested £10,000 in a broad spread of equities at the end of 1981, it would be worth about ten times its original value (at the end of 2006), after allowing for inflation. This compares with almost five times the original investment for bonds and three times for cash. However, past performance is not necessarily a guide to future performance.
However, the chart also shows the volatility of returns from equities compared to other asset classes, and in particular the negative returns achieved in the last few years. The equity value peaked at around £103,000 in 1999. It should also be remembered that investment in cash deposits offers security of capital, which is not the case with investment in either equities or bonds.
Source Factset
Figures use monthly returns on FTSE All-Share Index, FTSE All Stocks Gilts Index and representative cash returns. All figures are gross with income (gross) reinvested and have been adjusted for inflation. The value of investments can go down as well as up and you may get back less than you put in. Past performance is not necessarily a guide to future performance.
Property
In this context, property investment usually covers commercial properties, such as offices, business parks, shopping centres and industrial warehouse sites. The returns from a property investment come from the growth in the property's value and from the rental income received (less expenses) from the property's tenants.
Property has a number of unique features that make it different from some other investments:
- illiquidity – there is no "stockmarket" for property where investments can be bought and sold quickly. A single property transaction can take months to complete.
- valuation – unlike equities and bonds, whose prices are quoted regularly, the value of a property is only really known at the point of sale. Valuation at any other time is generally a matter of the valuer's opinion rather than fact
- costs – property can be an expensive investment to maintain, as the property's owner may have to pay additional fees to cover valuation, legal expenses and the maintenance of the property.
Property may be an appropriate type of investment for those investors looking for a degree of diversification away from other asset classes such as equities.
Aberdeen Asset Management Life & Pensions Limited does not provides advice on the suitability or otherwise of specific investment transactions. You should contact an independent financial adviser to determine an investment strategy which is most appropriate to your specific circumstances. The views expressed should not be construed as advice to either buy, retain or sell a particular investment and are those of Aberdeen Life as at the date of publication.