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Exploring our Investment Options

July 17, 2023
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FinMeUp
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FinMeUp

Overview of various asset classes available to investors.

Okay, youre ready to invest. The question is: in what? Should you invest in Bitcoin, Naspers, or gold?  Maybe you should just keep your money safe in a bank account, or maybe you should buy an apartment and rent it out. This article investigates the various investment categories available to investors and how they compare on the risk-return spectrum. Only once you are familiar with the various options available, can you make informed investment decisions.

The first step in the investment journey is assessing ones personal investment objectives and risk tolerance. Remember, everyones risk-return profile is different. Once youve established your investment profile, you need to figure out what to invest in. This is where the various options, called asset classes come into play. 

An asset class is a collection of investments that share similar traits. For example, all retail houses have walls and a roof and are thus classified as real estate. Sure, houses come in all kinds of shapes and sizes and are used by different people for different purposes, but they all share the same basic traits that put them in the real estate bracket. The main asset classes include cash and cash equivalents, bonds, real estate, commodities, equity, and cryptocurrency. 

Whatever your financial circumstance, the goal of investing should always be to earn the highest possible returns with the lowest potential risk. The graph below indicates how these asset classes compare on the risk and return spectrum. 

Cash and cash equivalents
A cash fund typically invests in a portfolio of cash and short-term deposits. The idea is to achieve a competitive rate of interest whilst maintaining safety and liquidity. Cash and cash equivalents can be utilized as a short-term safe haven or a temporary home for money between longer-term investments. 

Bonds
Purchasing a bond from an institution is the equivalent of granting a loan - you're essentially lending them money. In return, the institution will make interest payments on the loan, called coupons, on an annual or semi-annual basis. These coupons are paid to bondholders throughout the life of the bond. The principal amount is eventually returned to the investor at the maturity of the contract. 

For example, if you buy a R1000, 5-year bond with an annual interest rate of 6%, you'll receive 5 annual payments of R60 (R1000 x 6%) or 10 bi-annual payments of R30 (R1000 x 6%/2). The R1000 initial deposit will then be returned to you at the end of the 5-year period.

Equity
Equities (also known as ordinary shares, or shares) represent partial ownership in a public company. For example, if Company ABC issues 10 000 shares and you buy 2 000 of those shares, you will own 20% of Company ABC. Shares are traded on stock exchanges such as the JSE or NASDAQ. 

You can potentially profit from share investments in two ways, either by capital growth through an increase in the share price (buy low sell high) or by receiving income in the form of dividends (profits paid out to shareholders). 

Real estate 
Real estate comprises mainly of residential property, commercial property, and land. Investors can physically own property or invest in a real estate investment trust (REIT). A REIT is created by pooling investors money to purchase, operate, and sell income-producing properties. REITs are bought and sold on major exchanges, just like stocks.

The main advantage of real estate is its natural hedge against inflation. As economies expand, the demand for real estate increases, driving rents higher, as well as appreciating the capital value of the properties.

Commodities
Commodities are basic goods that are used as inputs to create other goods and services, like oil, gold, and wheat. Investors can physically hold commodities, but in most cases, it is traded on exchanges as derivatives. [Dont worry, derivatives are complicated. Just think of it as buying and selling digital versions of the various commodities]

Like real estate, one of the biggest benefits of investing in commodities is that they tend to protect investors against the effects of inflation. Generally, the demand for commodities tends to be high during periods of high inflation, which pushes up prices.  

Cryptocurrency
A cryptocurrency is a digital asset that can circulate without the need for a central monetary authority such as a government or bank. Cryptocurrencies are created using cryptographic techniques that enable people to buy, sell or trade them securely.

Bitcoin and most other cryptocurrencies are supported by what is known as blockchain technology, which maintains a public record of transactions and keeps track of who owns what. Many investors are still on the sidelines as crypto remains a technology that is not yet well understood or regulated.

 

Asset Classes and Diversification

Diversification is the practice of spreading capital investment across multiple asset classes to reduce risk exposure. Diversification is essential for risk management, as too much exposure to a single asset class can significantly deteriorate the value of ones portfolio.

For example, during periods of high economic growth, stocks typically outperform all other asset classes. However, during bear markets, bonds, real estate, and commodities are likely the better bet. It is also possible to diversify within an asset class. Stock investors commonly diversify by holding a selection of large-cap, mid-cap, and small-cap stocks. 

The extent to which you choose to employ capital is an individual decision that is guided by your personal investment goals and risk tolerance. If youre very risk-averse, you will probably lean more towards cash and bonds. Alternatively, if youre willing and able to take on more risk, stocks and crypto probably constitute the largest part of your portfolio 

Another guideline to take into account when choosing asset classes is risk tolerance relating to the age of the investor. The younger you are, the more aggressive your portfolio should be, as it is easier to digest and absorb losses at a younger age. As you get closer to retirement, your portfolio should comprise of more conservative assets as you have less time to rebound in the event of a market downfall.


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