In the introduction, we explained how returns on certain investments (government bonds) have fallen to an all-time low. Investment markets have also seen lower returns on bunds (German government investments), gilts (government investments with a guaranteed return) and treasuries (US government investments). In this section, we will look at the different types of investment funds being adopted by investors as a way to weather the economic storm.
In a financial crisis the returns may be lower but investors can still see a profit. No single investment is immune to risk, so a balanced and well-diversified portfolio is the best weapon against investment losses.
If you want to invest, consider:
- Developed stock markets (markets which are already established). These offer the best longer-term returns at a manageable level of risk.
- Fixed incomes (where the borrower repays the lender at fixed intervals) and equities (private investments into company shares) are another option to consider, but please be aware that these are more risky than other investments.
- Corporate bonds (an investment opportunity offered by a business) also offer good returns at the moment because cost-cutting companies are sitting on big piles of savings.
More about equities
“Equities” are payments made to a company for stocks and shares. They have become quite popular during the eurocrisis because they seemed “cheap”.
Equities pay out “dividends” to investors; essentially, they pay shareholders a portion of company profits. Shareholders actually own a part of the company. Dividends have a tendency to rise in value, not just in line with inflation, but also in line with the cost of living. They can also be reinvested (this is known as “compound interest”), which makes them quite an enticing prospect.
Finding a good equity can be quite a tricky business – it takes plenty of research to identify a good fund which is likely to turn a profit. It helps to understand a little about the business you are buying shares in; about its business model, the industry it sits within and also it helps to look at how reliably (and to what extent) dividends have been paid out to shareholders in the past.
Don’t be swayed by the equity promising the biggest return – if the fund is a high-risk investment you may never see any profit from it. It makes much more sense to minimise investment risks by simply doing your research about the company.
Try to identify businesses with what they call “pricing power”; these are those with a strong brand or which are government-regulated. Companies like these can pass on certain costs to their customers and they also offer more security.
High yield & investment grade bonds
Don’t be put off by low bond yields. Profit is good, but security is better! Corporate bonds – high-yield bonds – can offer the best return but they are riskier than other investments. Corporate bonds are slightly different to equities, because the investor is not a shareholder – they do not own part of the company they invest in. Instead, they simply afford the company credit.
Corporate bonds are another good option – companies are currently in the throes of cost-cutting, putting money aside because of the financial crisis. This means that they are sitting on piles of cash so investments have a good chance of performing well. Many companies have more money on their balance sheets now than they have done for decades. So, just as businesses should be able to maintain dividend payments, they should also be able to cover their bonds.
In PART 2 of our eurozone report, we give a general overview of the handling of the crisis, including:
- Political disagreements
- Potential outcomes for the most indebted countries
- The plans for raising repayments and moving from recession to growth