The problem

Here's what you know:

• You know what is meant by the 'return' on an asset. You are looking for high returns.

• You know that service costs can significantly damage returns.

• You know that the returns on assets are subject to uncertainty (or risk). You want to reduce risk.

• But you suspect that higher returns can be the reward for taking more risk. What you want to avoid is unrewarded risk.

• You know that liquidity has value.

• You know that inflation is a special sort of risk.

• You know that diversification reduces risk. So 'lots of different assets' is better than 'a few assets'.

You need to balance all these factors as you decide where to put your money.

In Easy Money we set you on your way by suggesting you only have two asset classes - cash and a low-cost equity fund invested in a wide range of shares. This will serve you well, forcing you to concentrate on the most difficult and important issue - the trade-off between risk and return.

A possible improvement

As you gain experience, and move through life’s stages, you will gain experience of handling this balance. You will be able to do two things:

• Introduce individual share ownership in place of some of your fund assets, and…….

• Introduce other asset types, such as property and bonds

By the time you get round to this, after several years, you will have had time to look at Hard Money, and we’ll leave further guidance to that module.

What is a share?

Before you take the ‘single shares’ step we need to explain what ‘share’ actually means.

‘Share’ is shorthand for a set of promises made by an enterprise set up to do something useful (e.g. search for oil or run restaurants) and requires money to do it. The enterprise obtains money for this purpose against a set of promises about what it is going to give back to the donor. There are any number of possible legal forms for this arrangement, but most developed countries have a preferred form which is named a ‘company’. The original suppliers of money (or original investors), usually receive promises of future payments (dividends) plus a share of any proceeds of sale. These promises are wrapped up in a legal statement (now usually virtual not physical paper) called a ‘share’ (short for ‘share of the company’).

In the UK all companies are governed according to two documents, unique to each company: ‘Memorandum of Association’ and ‘Articles of Association’. These define how the company is to be run and the circumstances in which its shares can be bought or sold.

Young companies often place restraint on share transfers - typically restricting to the founders or family. These are called private companies. Others allow unrestricted transfers. These are called public companies. Public company shares are tradeable - they can be bought and sold.

Shares are exchanged (‘traded’) on Stock Exchanges around the world. These are simply markets, each with their own trading rules and their own definitions of what they allowing to be traded. The principle British stock exchange is the London Stock Exchange (LSE). If a company can be traded on the LSE it is said to be ‘listed’.

The LSE is a public company listed on its own exchange. It runs two markets for shares defined by two different sets of rules: the Main Market and the Aim Market. The latter is typically for smaller and riskier companies. It is less protected by regulation but has some inheritance tax advantages.

The value of companies listed on the LSE is just 4% of the world total. But is still the world’s third largest after New York (60%) and Japan (6%)

Most companies are traded on just one exchange of their choice. But there is nothing to stop companies electing for more than one exchange.

Original owners need a way of retiring and disposing of their shares. Stock Markets satisfy that need and turn corporate ownership into a tradeable commodity open to all.

Private individuals have access to the LSE via brokers. Some brokers offer a wider range of services such as investment in funds. These brokers are called ‘platforms’

As a private individual investing via a broker/platform you are not actually a shareholder at all (although, shamefully, the regulations allow you to be described as such). The shareholder is the platform. When you ‘buy’ the platform buys for you. Through its contract with you it passes on most, but not all, of the ‘promises’ it has received. It does not pass on voting rights.

You need to consider these things as you develop your savings habits. It affects your counterparty risk.

Next steps

You have two other major decisions which interact with the above. How do you finance your home? And how much of your savings do you put into pensions?

But never lose track of your basic savings process

• How much do you have?

• How much do you expect to have?

• What’s the cash/other assets split?

• Repeat