Investing can seem like a daunting endeavor with its continually changing dynamics and seeming complexity. However, by spending a little time comprehending fundamental principles and the variations in asset classes, you can set yourself up for substantial long-term gains.
Understanding different types of investments and where each one falls on the risk ladder is integral. Below, we unravel the primary asset classes and how much risk each one carries.
The journey to understanding investments often begins with a cash bank deposit - the simplest, easiest to grasp, and safest investment. With this type of investment, you know exactly how much interest you'll reap and, most importantly, your capital is guaranteed to be returned.
However, interest from savings often doesn’t keep pace with inflation. Certificates of deposit (CDs) offer higher rates. Still, your money is tied up for a specific duration, and you could face penalties for early withdrawal.
Bonds represent loans from an investor to a borrower. Usually, a corporation or a government agency agrees to a fixed interest rate for using the investor’s capital. As interest rates significantly influence bond rates, bonds see a lot of trading during periods of quantitative easing or when central banks, such as the Federal Reserve, hike interest rates.
Mutual funds involve several investors pooling their money together to purchase securities. These are not necessarily passive investments, as portfolio managers distribute the collective investment into various stocks, bonds, and other securities. Despite these advantages, it's important to consider the higher costs of actively managed funds, such as annual management fees and front-end charges.
Exchange-traded funds (ETFs) have seen a rise in popularity since their debut in the mid-‘90s. They resemble mutual funds but are tradeable throughout the day, much like stocks. This flexibility means that ETF values can fluctuate greatly in a single day.
Shares of stock allow investors to share in a company’s success via increases in the stock’s price and through dividends. Although shareholders have a claim on the company’s assets if bankruptcy occurs, they do not own the assets.
Certain investments, like hedge funds, are available only to affluent investors.
The key to successful investing lies in managing a diversified portfolio in accordance with your risk tolerance. Most experts would suggest you start simple and gradually expand your portfolio. Starting off with mutual funds or ETFs is considered a good first step before delving into individual stocks, real estate, and other alternative investments.
For the busy investor, sticking with index funds that mirror the market is a good strategy. Steven Goldberg, a principal at Tweddell Goldberg Wealth Management, suggests that three index funds could be sufficient for most: one covering the U.S. equity market, another for international equities, and the third one tracking a broad bond index.
Those preferring a more hands-on style can choose their preferred asset mix. This approach enables you to potentially yield more returns by favoring certain asset classes depending on the current economic climate.
A mix of stocks and bonds is recommended by most financial experts. Other asset classes also favor certain economic conditions, although not all asset classes are suitable for every investor.
Historically, the primary asset classes have been equities (stocks), debt (bonds), and money market instruments. Today’s investors also count real estate, commodities, futures, derivatives, and cryptocurrencies as separate asset classes.
Investment education is vital, as is steering clear of investments you don't wholly understand. Count on reliable advice from savvy investors, avoid fleeting "hot tips," consult impartial financial advisors (who get paid only for their time), and most important, diversify your assets across a wide range of options.