Cash

Cash investments increase in value by earning interest at a fixed or variable rate.

Cash investments include:

• bank and building society accounts;

• national savings accounts;

• other interest paying accounts.

In cash investment funds your money is invested with potentially millions of pounds from other investors to get the best interest rates.

Benefits

Cash investments offer:

• security — the risks to your capital are minimal;

• easy access to your money, although it may be tied in by a notice period or a fixed term;

• a clear, interest rate based return.

Risks

If your interest rate is lower than the rate of inflation, the buying power of your money will go down.

For example, if you have an interest rate of 3.9% and the annual rate of inflation is 6,4%, your savings will lose value by just under 2.5% each year — though the actual amount will still increase. On a USD 10,000 investment, that's a loss of almost USD 250 buying power a year.

Bonds

Bonds are also known as fixed interest securities — they can be bought for a set term, and they pay out interest at a fixed rate. There are two main types:

• gilts — issued by the Government or local authorities

• corporate bonds — issued by companies

Bonds allow the bond issuer to raise funds by borrowing money from the public. In return for the loan, they make regular payments at a fixed rate of interest. These payments are called coupon payments.

You don't have access to your money during the period of the term, although bonds can be traded on the stock market. When the term ends, the bond issuer repays the original amount — known as the par value.

Unit—linked bond funds

You can invest in bonds directly or via unit–linked bond funds, when your money is pooled with that of thousands of other investors.

This allows fund managers to invest in bonds from a wider range of companies, which can reduce the risk to your money, but also reduce its potential growth. If one company performs particularly badly or well, the effect is offset by the rest of the fund, which reduces the impact.

Benefits

• Bonds provide a regular income, potentially higher than that from a bank or building society account.

• A skilful fund manager can achieve a higher rate of growth than the average bond, or reduce the impact of a falling market by buying or selling at the right time.

• If you have invested in a corporate bond and the company is wound up, it must repay its bondholders before its shareholders. The same applies to interest payments.

• In general, bonds are lower risk than equities.

Risks

Bonds are affected by two main risk factors:

• credit risks

• interest rate risks

Credit risks

The risk to your money depends on the credit worthiness of the issuer. If a company is stable and financially secure, it's more likely to be able to repay your loan, meaning less risk and a lower interest rate.

Low-risk companies are known as investment grade. Bonds issued by less secure companies are known as non–investment grade, or junk bonds.

UK Government bonds are considered to be virtually risk–free because the Government could increase taxes in order to repay the loan. Bonds issued by other governments may carry more risks.

Interest rate risks

When the Bank of England changes interest rates, your bond will be more or less valuable depending on the direction of the changes made.

If interest rates become higher than the rate of your coupon payments, your money is earning less than it would if it was in a bank, where it is also more secure. This cuts the value of your bond, because nobody will buy it from you unless it's sold for less than its original value.