FOOL'S EYE VIEW
A Plain English Guide To Investment

By Cliff D'Arcy
February 18, 2003

Make no mistake: the world of investment is vast and baffling. There are thousands of different products, providers, salesmen and advisers, not to mention an enormously complicated tax regime and legislation regulating the whole lot.

These elements, together with overly complicated industry jargon, make it almost impossible for the average investor to know where to begin.

To help you see what you want from your investments more clearly, here are the questions you should ask. Although there's no definitive list, these should help you to get a better grip on what you want and what you need to know:

What product do I want?

Essentially, you're either investing income to create capital or investing lump sums to grow or create income. You probably have a fair idea of why you want to put money aside: "rainy day" money, saving for children, saving for retirement, a round the world trip, etc.

You should have a pretty good idea of your attitude to risk: do you want your capital and income to be entirely safe? If so, tax-free deposit accounts and bonds are probably your best bet. However, if you are willing to take stock-market risk, where your capital and income can fluctuate, you'll be looking at collective investments or individual shares.

Decide in advance what guarantees you need and the risks you're prepared to take. This will be one of your elementary rules to choosing products.

Starting out? Read the Fool's beginner's guide to investment.

Where can I buy it?

Thanks to a hugely competitive market, financial products are available from almost anywhere: banks, building societies, retailers, supermarkets, travel agents, insurers, brokers, salesmen and independent financial advisers.

Thanks to this fierce competition and extensive choice, it almost doesn't matter where you buy your products, so long as you've done your research and shopped around first. Many major financial mis-selling scandals could have been lessened if consumers had listened to the salesmen a little less and done a little more homework themselves.

Remember, professional advice can be expensive: you may not want it if your needs are fairly straightforward.

What are my commitments?

Before you sign anything, understand what your commitments are. You may be putting in one lump sum, or signing up to monthly payments for a twenty-five-year period.

Make sure you can afford the payments - and are prepared for any agreed increases along the way. Otherwise, you could lose out.

What risks do I face?

Are you guaranteed to get back all of your money, no matter what happens to the UK (or world) economy? Are you getting a guaranteed income but putting your capital at risk? Are you taking full stock-market risk in order to access potentially higher returns?

If you don't understand the features and risks of the product you're considering, don't buy it. Otherwise, you're like a gambler playing a game he doesn't understand. I've seen this in casinos and it ain't pretty!

For how long am I in?

It's critical to know your timescale.

If you buy shares in a FTSE 100 company, you can sell them to another buyer seconds later, as the market for these shares is very liquid. However, if you buy a mortgage endowment, unless you pay 300 premiums over 25 years, your returns could be heavily reduced, even negative.

If you need to get hold of your money at short notice, stay away from the stock market. Instead, look at cash savings accounts - cash mini-ISAs pay tax-free interest and most offer instant access.

How flexible is this product?

There's nothing more frustrating than being locked into a poor-value product and not being able to do anything about it - just ask victims of the mortgage endowment, personal pension and free-standing AVC scandals.

If you want a product that allows you to increase, decrease, stop and start your payments without penalty, don't buy one that is rigid and inflexible. Watch out for early surrender penalties and other fees, and notice (lock-in) periods.

Sometimes, flexibility comes at a cost, so beware of long-term savings products that allow you to be flexible with payments, thanks to high charges: "whole of life" insurance policies are a classic example.

What charges will I pay?

It's in your interest to shop around for low-charging products, since the higher the charges, the lower your overall return. Ask for charges to be explained in pounds, as a percentage of your payments and as a proportion of your total commitment. The total charges over the life of some products can be staggeringly large.

There is clear evidence of a direct link between high charges and below-average investment performance, despite what financial advertisers want you to believe.

That's why Fools prefer low-cost index trackers to high-charging managed funds. Despite their highly paid and qualified professional managers, 80% of managed funds fail to beat a simple market tracker.

Remember, your payments also pay any salesman or adviser. Ask him what he's getting out of the deal, in pounds, as a percentage of what you're paying in and as a percentage of your overall commitment. It often comes as a shock to discover than someone can make a couple of thousand pounds for selling you one simple, long-term product!

Cutting out the salesman and directly approaching a company can backfire, since the firm will often levy the same charges and keep the salesman's commission! That's why the best deals - the lowest charges - often come from "discount brokers", who offer a basic service and discount the commissions they receive from providers. This means more of your money is invested from day one, boosting your returns.

When can I exit?

There's no point in signing up to a ten-year savings plan if you need the money the year after next. Make absolutely sure that the exit point for your investment coincides with the time you need the money.

The stock market isn't the place for investments with a timescale of less than five years. If you're saving over any period shorter than this, you should be leaning towards deposit-based products.

What if all goes wrong?

Despite a highly regulated market, financial scandals still happen in the UK. Beware of fraud, mis-selling, misleading advertising and poor-value products.

Obviously, some products and institutions are safer bets than others. Usually the bigger the firm, the more secure your investment - the UK government being one of the safest providers. Nevertheless, don't expect High Street providers to offer the best deals - often, the reverse is true.

If you've lost money unfairly, and no-one's taking your complaint seriously, there are several financial regulators protecting UK savers, the most prominent of which is the Financial Services Authority (FSA).

The FSA is responsible for maintaining an orderly market for UK investments, can fine firms for breaking the rules, and award compensation to investors that have lost out. If all else fails, call the FSA helpline for advice.

The FSA website also includes various consumer help factsheets to help guide your investment decisions.