Making Your Spare Cash Work Harder

So all that hard work has paid off. The SSBS has done its job and now you find yourself with some extra cash lying around and you’re not sure what to do with it. Well you have a number of options, one of those is lending it to the Government or companies (known as buying bonds) or buying a stake in a company (known as buying stocks).

I’m reluctant to use the word ‘investing’, purely because it instantly brings up images of gambling and people like Jordon Belfort.

I want to make this as clear as possible. With a little effort (and I’m talking about doing a small amount of reading) you will realise that the term ‘investing’ isn’t the big scary complicated monster, you may think it is. Investing does not have to the equivalent of putting all your money on black at the roulette table and waving goodbye to your hard earned cash.

I’m going to quickly talk about 2 of the most widely bought asset classes, stocks and bonds. No problem if you’re unsure what an ‘asset class’ is, here’s a nice explanation: Asset Class. I’m going to keep it short in the hope you don’t lose interest, so please bare with it, you’ll be glad you did when you’re done.

Bonds

First off, what is a bond and why would I buy these with my spare cash? Put simply a bond is a loan from you to the Government or company. The Government or company will put a price and time frame (known as maturity) on the life of the bond and a rate of interest (known as a coupon) you will earn for loaning them your cash. Once the time frame is up on the bond (it hits maturity) you get the cash back that you paid for the bond. For example:

Company A are offering a 5 year bond with a 5% coupon for £100. So the math plays out like so.

You buy 1 bond for £100.

Every year you’ll earn 5% interest on the £100. So 100 * 0.05 = £5

After 5 years you will get your £100 cash back and have earnt £5 (interest earnt per year) * 5 (number of years) which is £25. Which gives you a grand total of £125.

Government bonds are considered safer than company bonds because the Government isn’t likely to go bust anytime soon. However, because of the relative safety of your cash, the interest rate the Government offers is usually much lower.

How do I buy bonds?

Buying individual Government bonds can be done via the NS&I website.

As for buying company bonds. You will have to investigate this yourself as I’ve never bought a company bond directly. However, it’s not going to be any more complicated than buying a bond from the Government.

Stocks (also known as equities)

What is a stock and why would I buy these with my spare cash? A stock is you buying a stake in a company and in return for buying a stake in the company, you will be entitled to regular payouts known as dividends.

Similar to bonds paying interest, stocks pay out dividends. Dividends come from the companies profits and it’s a sort of thank you from the company to the shareholder for taking the risk and buying a stake in that company. The biggest difference between bond interest and a stock dividends is, a company does not have to pay its shareholders dividends. Companies set when a dividend is paid, so a company may decide on paying a dividend every 3 months, every 6 months or once a year. It all depends on the company as to when this happens.

As well as the dividends the stock price may increase or decrease overtime. Ideally you’ll want the stock price to increase but this is not a guarantee. A stock price may increase or decrease for many, many reasons. Imagine you buy stocks in a pharmaceutical company and they find a cure for a widespread disease and they are the only company that can produce the drug. Based on this information, the company is likely to be more profitable in the future due to the research breakthrough and so the stock price will likely increase. However, this works both ways, the company may be trialing a drug and the results come back as it’s no better than a placebo. This would then likely cause the stock price to fall as the company’s profits may not be as high in the future due to the new drug not being a success.

How do I buy stocks?

You buy stocks through a ‘brokerage’. A brokerage is the middleman between you and the company you want to buy stocks for. They will handle all the complexities of buying the stock upon your instruction. For this they charge for each transaction. They will also charge a fee for holding the stock for you. This is usually a percentage of the total value of your stock portfolio (read that as the total value of all the stocks you own).

Monevator has done an absolutely outstanding job of comparing online brokers for UK investors: Compare the UKs cheapest brokers

Conclusion

If you’re now a little pissed because you’ve just spent a good 10 minutes reading this and although it all sounds like a good idea, it’s still confusing and seems risky, then don’t worry. You’re right to think it’s risky. Investing in bonds and stocks like this is about as risky as it gets. Now you may be thinking, OK, so I was right about it being risky, how do I reduce the risk but still take part so my spare cash works harder for me? Well, you’re going to love the next installment on this. It’s called indexing and it comes with some massive advantages for the average investor like you and me. It’s the equivalent of putting the eggs you own in many, many baskets without needing to think about it too much.