Types of Investment in the UK

Investing for the future can allow investors to build their wealth over the long-term and help secure their financial security later on in life. But with all the options available to investors these days, getting started can be quite daunting.

In this article, we will take a comprehensive look at the most common types of investment and financial products which are available to UK investors, examining how they work and highlighting their differences to help you decide which investment is best for you.

Types of Investing Accounts

Before you start investing, you will need to open an account which provides access to the financial markets and, in the UK, there are a number of different options available.

Before we look at different types of investments, let's examine some of the different accounts UK investors can use to access the markets. In the following sections, we will explain how these products work and highlight some of their advantages and disadvantages.

Stocks and Shares ISA

A stocks and shares ISA (Individual Savings Account) is a type of UK investment account available to UK tax residents. As the name suggests, the account can be used to invest in the stock market, buying individual shares or funds.

Unlike ordinary investing accounts, investments held in a stocks and shares ISA are exempt from tax. This means that investors do not need to pay any tax on income or capital gains generated from investments which are held in an ISA.

However, investors will incur fees from their ISA provider. Typically, ISA providers will charge an annual management fee, which is usually charged as a percentage of the total value of your ISA holdings. Share dealing charges will also apply.

Furthermore, there is a limit to how much you can invest in ISAs each tax year. At the time of writing, this limit is £20,000 per tax year.

General Investment Account

A general investment account can provide investors with access to a wide range of assets, including stocks, mutual funds, Exchange-Traded Funds (ETFs) and bonds.

Unlike a stocks and shares ISA, there is no limit on how much you can invest using a general investment account. Moreover, whilst investors will likely be required to pay commissions on transactions, many brokers offer general investment accounts with no account maintenance fees.

However, any income and returns will be subject to tax, the exact level of which will depend on your individual circumstances.

Pension

Employers in the UK are obliged to give employees the option of enrolling in a workplace pension, into which both employer and employee make contributions. Employee contributions are taken before tax. 

As well as, or instead of, a workplace pension, UK investors may choose to pay into a personal pension.  

Personal pensions give investors more control over how their pension pot is invested. Self-Invested Personal Pensions (SIPPs), in particular, provide investors with a wide range of investment options and the power to actively manage their portfolio.

Investors who pay into a personal pension will also receive tax relief from the government. Typically, a pension provider will claim this on the investor’s behalf and automatically add it to their pension pot.

However, there is an annual allowance of £60,000 which is the maximum investors can pay into their pension before having to pay tax on contributions. This allowance may be lower if you have a higher income.

Whilst there are undoubtedly tax benefits involved in investing money in a pension, it’s worth highlighting that it’s not possible to withdraw money until you reach a specific age.  

Currently, the minimum age is typically 55, although this can vary depending on provider. This is in contrast to a stocks and shares ISA or a general investment account where withdrawals can be made at any time.

Consequently, although it is important to make provisions for retirement, investors should avoid investing money which they will need before retirement.

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Types of Investment

The world of investing is vast, with many assets and investment vehicles to choose from. Each type of investment works in its own way and has its own list of advantages of disadvantages. In the following sections, we will highlight some of the most common investment types and explain how they work. 

Stocks

When it comes to investing, stocks are probably one of the first assets to spring to mind for most people.

When investing in stocks, investors are buying a portion of a company. The success of the investment, therefore, is dependent on the success of the company, meaning that investors should thoroughly research a company before buying its shares.

Investing in the stock market carries a high level of risk. However, as is often the case, this higher risk can be accompanied by larger potential rewards.

The exact level of risk depends on the company in question. The shares of large, established and financially sound companies – sometimes referred to as blue chip stocks – will be accompanied by lower risk than those of smaller, less established companies.  

However, in theory, blue chip stocks also have lower potential returns, as the companies have less room to grow than younger, smaller companies.

Bonds

When an investor buys a bond, they are essentially lending money to the bond-issuer who, in turn, undertakes to repay the principal sum on a fixed date in the future together with any applicable interest.

Consequently, returns from a bond are fixed – hence the name “fixed-income instrument” - and are limited to the rate of interest agreed when the bond is initially issued. They offer investors the ability to generate regular and, in theory, reliable income from their investment.

However, although bonds are considered to be a relatively low risk investment, they are not without risk. Default risk is always a possibility. If the issuing entity defaults, bondholders can lose part or all of their original investment.

The level of risk depends partly on the creditworthiness of the issuing entity, and this will be reflected in the amount of interest the bond pays.

Bonds with a higher risk of default, known as junk bonds, will tend to pay a higher yield to investors. On the other hand, lower risk bonds, known as investment-grade bonds, tend to pay a lower yield.

Exchange-Traded Funds

An Exchange-Traded Fund (ETF) is a basket of securities which can be designed to track an underlying sector, index, economy, commodity or anything else. ETFs are listed on a stock exchange and can be traded throughout the day in the same manner as stocks.

Since ETFs are composed of a group of securities, they offer investors instant and low-cost diversification through a single investment, which can help reduce portfolio risk. They also allow investors to gain exposure to a market without having to pick individual stocks. However, unlike stocks, ETFs charge an annual management fee.

For example, if an investor is feeling bullish about the UK economy, rather than picking individual stocks which could benefit from this, they could invest in an ETF which tracks the FTSE 100 or the FTSE 250.

Most ETFs are passively managed, which means that they merely aim to track an underlying index. However, you can also find actively managed ETFs, which have managers who make decisions about which securities to include in the fund’s portfolio. Due to the increased management, active ETFs are typically accompanied by higher fees.

Some examples of ETFs include:

• L&G Artificial Intelligence UCITS ETF 
  • An ETF which tracks an index composed of companies which derive a significant portion of the revenue from Artificial Intelligence. 
• iShares FTSE 100 UCITS ETF
  • An ETF which tracks the FTSE 100, an index composed of the 100 largest companies listed on the London Stock Exchange. 
• SPDR S&P UK Dividend Aristocrats UCITS ETF 
  • An ETF which tracks the performance of an index composed of UK dividend paying stocks.
• iShares Core UK Gilts UCITS ETF 
  • An ETF which tracks an index composed of UK government bonds.

Mutual Funds

A mutual fund is a fund which pools money from investors in order to invest in a portfolio of securities. Like ETFs, there are many different types of mutual fund, and they can be either actively or passively managed. However, there are some key differences.

Unlike ETFs, mutual funds are not bought and sold on stock exchanges. Their shares can only be traded once a day after the market has closed, which offers investors less flexibility when buying and selling.

Furthermore, whereas the price of an ETF fluctuates throughout the trading day based on supply and demand, mutual funds are only priced at the end of each trading day based on the Net Asset Value (NAV) of the fund’s portfolio.

However, although some brokers may facilitate fractional investing for ETFs, it is not standard. On the other hand, although mutual funds will have a minimum investment amount, investors can purchase fractions of shares. This can make mutual funds a good option for those interested in dollar-cost averaging.

Investment Trusts

Investment trusts are public companies which invest in other companies in an attempt to generate a return for their shareholders.

Just like any other public company, an investment trust issues shares to raise capital, which it then uses to fund its investments. They are what is known as closed-end funds. Once created, they have a fixed number of shares and fund managers are not able to issue new shares without shareholder approval.

This is in contrast to most mutual funds, which are open-end funds. Fund managers of open-end funds are able to issue shares as long as there is demand for them, meaning they can, in theory, have an unlimited number of shares.

Consequently, whereas investors can buy shares in open-end funds directly from the fund manager, when you buy shares in an investment trust, you will typically be buying them from an existing shareholder on the secondary market.

Examples of investment trusts which are listed on the London Stock Exchange include Pershing Square Holdings and the City of London Investment Trust.

Unit Trusts

A unit trust pools investor capital to invest in a portfolio of assets, such as stocks, bonds, property and so forth. 

If you’re thinking that this sounds a lot like a mutual fund then you’d be right, they are similar. The key difference is how they’re structured. 

As the name suggests, a unit trust is structured as a trust. A trustee holds the assets on behalf of investors whilst the investors are designated as beneficiaries of the trust. In contrast, when investing in a mutual fund, investors are buying a share of the fund itself. 

Real Estate Investment Trusts

Real Estate Investment Trusts (REITs) are companies which own and, typically, manage a portfolio of income-generating property such as shopping centres, warehouses and apartment blocks.

Consequently, REITs offer investors the opportunity to gain exposure to income-generating property without the high costs or headaches involved with buying and managing these types of properties themselves.

Companies which qualify as a REIT enjoy preferential tax treatment, but in order to qualify as such, they must meet certain conditions. These conditions vary from country to country. For example, in the UK, REITs must:

• Distribute a minimum of 90% of their tax-exempt profit to investors as a dividend.
  • This can make REITs a good option for investors who like to generate income from their portfolio.
• Not be an open-end investment company.
  • As we saw with investment trusts earlier, once created, a REIT cannot issue new shares unless it has shareholder approval. 
• Cannot be a close company.
  • A close company is a company which is controlled by five or fewer investors. UK REITs have an initial three-year grace period to comply with this.

There are other criteria which UK REITs must meet but these are a few of the most important. At the time of writing, there are almost 50 REITs listed on the London Stock Exchange. An example of one of these is the Tritax Big Box REIT, which invests in warehouses and logistics centres.

Alternative Investments

As well as the more conventional investments highlighted above, investors may also consider alternative investments. The term alternative investment essentially covers assets which do not fit into the more traditional categories of stocks, bonds and cash.  

In the following sections, we will highlight several of these alternative investment options. 

Property

REITs provide investors with an affordable and convenient way of gaining exposure to property. However, for some, investing in physical property might be an option.

There are a number of reasons why investing in property may be appealing to investors, such as:

• Rental Income: Investors may be able to generate a steady income through letting their property. 
• Opportunity for Capital Growth: The price of property has historically increased over time, although that doesn’t mean it always will. 
• Hedge Against Inflation: Historically, the property market tends to perform well in inflationary environments.  
• Diversification: The property market tends to perform differently to other asset classes, making it a good option for diversifying an investment portfolio.

However, there are many things to consider when investing in property, not least of all the large amount of capital required. Managing a rental property can be hard work; of course it is possible to outsource this responsibility, but that can increase costs significantly.  

Furthermore, unlike more conventional asset classes, property can be very illiquid. In other words, it can take time and considerable effort to convert your investment back into cash when you need to.

Private Equity

Private equity involves investing in private companies or taking over public companies with the goal of taking them private. In either case, private equity seeks to make better returns than can be achieved in the public markets.  

There are many ways in which private equity firms operate. Some remain passive investors in a company, whereas others will prefer to gain influence over the company’s operations to help them grow. 

Private equity opportunities may not be feasible for retail investors, as they typically require very deep pockets to get in on the action. Nevertheless, for those interested in gaining exposure to the industry, there are a number of publicly traded firms which are involved in private equity, such as Blackstone. 

Hedge Funds

Hedge funds are actively managed investment funds which use a wide range of investing strategies to try and obtain higher than average returns for their investors. 

These strategies are typically more aggressive and riskier than the ones employed by other types of funds and can involve using leverage, short selling and trading using derivative products.

Hedge funds are only available to institutional investors and high wealth individuals who can weather the high risks involved. Consequently, minimum investments are high.

Choosing the Right Investment

As you can see, when it comes to investing, there is no shortage of options available. The type of investment which is right for you will depend on your investing goals, the amount of capital you are able to invest and your tolerance to risk. 

Generally speaking, the lower an investment’s risk, the lower its potential returns and vice versa. Although remember that even investments which are considered to be “low risk” are still accompanied by a certain level of risk. That’s why you should only invest money which you can afford to live without. 

The information provided in this article is for educational purposes only. If you are unsure about which type of investment is right for you then you might want to speak to an independent financial advisor.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.