There are various types of assets, classified into different Asset Classes. Each has its own features and benefits, let’s look at them.
“Where should I Invest My Money?” is a common question asked by everyone. In today’s modern era, there are so many different avenues where an investor can put his money; it may seem overwhelming to someone who is just beginning his/her investment career; and is trying to understand the pros and cons of various asset classes. Let’s take a look at some asset classes that are available in the market; where you can put your money to meet your financial objectives.
What is an Asset Class?
In simple terms, an asset class represents a group of financial assets that have a similar structure; in terms of how you can invest in them and the rules & regulations that they are subject to.
Different Asset Classes
There’s no formal boundary which separates one asset class from the other; and consequently there’s no fixed number of asset classes that are present. You may find several people talking about 7 asset classes, some about 5, and some about 4. We are going to cover the most popular and major asset classes in this article.
The safest and the simplest option available is to put your money in a fixed deposit in a bank. The bank would pay you a fixed rate of interest on the amount of your deposit; and it won’t be affected by the market fluctuation or the economic conditions; you will be guaranteed a rate at which you will regularly get interest on your deposit.
It may sound lucrative at first, but the biggest downside of a cash deposit; is that the rate of interest is quite low; as compared to what you can earn by investing in other asset classes. This is the primary reason why most investors don’t prefer to keep their money in bank deposits; because generally the rate of interest is just barely sufficient to cover the inflation rate in the economy.
One of the ways in which a company can raise money from the market without diluting its equity is to issue bonds. A bond is a financial instrument that represents a debt; given by an investor to the borrower (a company or a government institution). Just like equity shares, a bond is split into small units which people can invest in through the open market. Similar to a loan, a bond would generally pay a fixed rate of interest to the investor/lender who has ownership of the bond.
The rates of interest for different bonds vary depending on the credit rating of the issuer among other factors. Generally speaking, bonds give a higher return than bank deposits; and are also a little riskier since different kinds of listed companies can issue bonds; so it is important to do a fundamental analysis of the issuer before investing money in a bond.
Overall, bonds are still considered a safe investment option; since they guarantee a fixed rate of return to the investor; and bondholders are paid before the equity shareholders in case of liquidation of a company.
A mutual fund is a portfolio of securities in which multiple people pool their money to invest. Generally, a mutual fund institution would create a portfolio of different stocks in the market; with an objective to achieve a good risk-return ratio (higher possibility of return while minimizing risk). Investors can purchase small units of this mutual fund through the institution directly or through some third party.
Mutual funds are affected by the market fluctuation; since their value is derived from the market value of the underlying stocks in the portfolio. Therefore, they carry some level of risk and also provide a decent return on investment amount. The performance of a mutual fund depends on the fund managers; and their historical return data can be found online with a simple Google search.
Since mutual funds try to combine stocks in a way that minimizes the level of risk for investors; they are less risky than directly investing in the open market, but their return is not guaranteed; and ultimately depends on the market performance.
One of the most popular ways in which experienced investors invest money in the market is through equity stocks. These are among the riskier asset classes; and the level of risk totally depends on the specific stock that an investor is investing in. Generally, it can be said that it is safer to invest in large blue-chip companies with strong fundamentals; than small companies but the return levels are also adjusted accordingly.
If you’re choosing to invest in equity stocks; you need to understand the exact specifics of the particular company that you’re investing in; and should also do proper fundamental and technical analysis of the company’s stocks.
Equity stocks have the potential to give a lot of return but can also carry huge levels of risk along with it.
Derivatives (Futures & Options)
The next type of assets that an investor can make money from are Derivatives. As the name suggests, these are financial securities that derive their value from an underlying asset like a company’s stock.
Derivatives provide investors an opportunity to make money in the market with less initial investment; since they do not require immediate purchase or sale of a stock. Therefore, the rate of return can be very high for these investments. However, they also carry a very high level of risk with them; and therefore, derivatives should only be used by experienced investors; who understand all the fundamentals of how the market functions and reacts to different happenings.
There are other forms of investment as well, like:
- Real Estate: A small investor can invest money in the real estate sector; through a financial instrument known as Real Estate Investment Trust (REIT). It is like a mutual fund for real estate investment; in the sense that a group of investors pool small sums of money to combine and invest into the real estate sector. The return in this form of investment varies from place to place; and depends on the performance of the real estate market.
- Commodities: Just like the stock market where you can invest in different companies; there are Commodities Exchanges as well where you can invest money in products like gold, silver, etc. Both return and risk would depend on the performance of the specific commodity that an investor is investing in. Gold is considered one of the safer options since historically it has consistently gone up in prices in the long-run.
- Hedge Funds: These are like mutual funds, but they don’t invest in the general stock market. Instead, they invest in other asset classes like start-up funding, real-estate sector, venture capital, etc. Generally, High Net Worth Individuals invest in Hedge Funds; after carefully analysing the capability and performance of the hedge fund manager.
There are various asset classes available in the market; which one suits you depends on your individual financial objective and capacity to invest. A smart investor would diversify his portfolio by investing some amount in multiple asset classes. This would reduce his asset concentration risk; providing him a cushion from one asset in case of a downfall in another one.
Before you invest in any asset, ask yourself whether the risk-profile and risk-return ratio of that asset meets your financial goal; and what will be your plan of action in case things don’t go as per your expectations. Will you be able to handle the probable downfall in that investment? Are you comfortable with its historical performance and market expectations? Questions like these will empower you with rational thinking; and enable you to take well-informed decisions.
Hopefully this article was able to provide a good understanding of different asset classes that you can invest in. Although it certainly doesn’t cover all the assets that exist under the sun; but I have tried to cover the major ones that you might be interested in.
Please let me know your thoughts in the comments below.
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