The five investment terms you need to know

Investing
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Find out what terms like investment risk, diversification and compounding really mean in our jargon-free guide

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23 November 2022 | 3 minute read

If you’re relatively new to investing, you’re likely to come across terms that you don’t fully understand. This can make investing seem daunting, but strip out the jargon and you’ll soon realise there is no reason to feel intimated.

To help you feel more confident, we’ve listed below five common investment terms, with a simple explanation of what they really mean.

1. Investment risk

Investment risk refers to the chance of an investment falling in value. In general, the riskier an investment is, the higher its potential rate of return; however, you could experience big ups and downs along the way and there are no guarantees.

All investments carry some degree of risk – shares, bonds and property can all lose value if market conditions sour. Even holding cash comes with inflation risk, which can erode your money’s real value over time.

You can minimise risk by spreading your money across a range of investments – otherwise known as diversification.

2. Diversification

You’ve probably heard the saying, ‘Don’t put all your eggs in one basket’. When it comes to investing, this is a really important phrase to follow. If you invest in one thing and it falls in value, you risk making a loss on your entire investment.

Diversification essentially means putting your money in several different types of investments. This includes different asset classes – such as shares, bonds, property and cash – as well as sectors and regions. These tend to perform differently in a range of market conditions, so when some investments perform poorly, the others may perform well and help to limit your overall losses.

3. Asset allocation

How much money you put in each asset class is known as your asset allocation. You might, for example, choose to invest 80% of your portfolio in shares and 20% in bonds. The asset allocation that’s right for you will depend on a range of factors, including your attitude to investment risk, how much money you can afford to lose, and how long you’re investing for.

4. Time horizon

The length of time you’re investing for is known as your time horizon. Generally speaking, the longer you’re investing for, the more investment risk you can afford to take on. This is because you have more time to recover from dips in performance. For example, a 30-year-old who is investing for retirement may wish to invest more of their portfolio in shares than a 55-year-old.

For goals that are less than five years away, it’s usually wise to keep your money in cash. The date you need your money could be too close for your portfolio to recover from a market drop. You should always view investing as being for the long term.

5. Compounding

The beauty of investing over long periods of time is that you can benefit from the power of compounding. This is where you get returns on your returns as well as on the initial capital. Over the long term it can make a huge difference to the sums you accrue, which is why it typically pays to start investing as early as you can.

As an example, if you invested £10,000 over two decades, earning an average of 5% a year after charges and before inflation, your pot could grow to £26,532, of which more than £16,000 would be compounded investment returns. Over 40 years, the original £10,000 investment could balloon to £70,399.

Next steps

Investing can be a powerful way of growing your money over the long term, but it’s really important to invest in a way that suits your individual circumstances. Getting some smart advice will help you understand how much you should be investing and where, so you can feel confident you’re doing the right thing with your money. For smart advice that’s tailored to you, speak to one of our advisers today.

The value of investments, and any income from them, can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy.

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The value of investments and any income from them can fall and you may get back less than you invested.