The most common question that is asked before getting started or halfway through the investment process is the type of investment and how to diversify it. Here we touch on the basics to understand the different investing options and their nature.
Investment types based on outcome and risk
Investments can be typically categorized into 2 based on the nature and outcome of the investment.
As the name implies, the emphasis is to grow the invested value with low- medium risk. Preferred mostly as a medium or long term investment the risk mostly is the market condition that might even eat into the principal amount invested.
Investments that prioritize safety over returns come under defensive investment. They are available both short term and long term and make sure the principle is safe irrespective of the market ups and downs. Defensive investments usually have comparatively low return rates than growth investments but the risk on principal value is low or zero.
The five main asset classes or investment types based on the method
The investment medium or method is where your money goes and what you get in return for the money – shares in the company, bonds, certificates, assets etc.
Every investment method is based on one among the following ways or the combinations of it –
(i) Lending money for an interest, (ii) holding a part ownership of a business or (iii) buying assets that tend to increase in value over time or give regular returns in the form of rent.
Now to the 5 important and traditional investment methods,
Cash investments are more of a savings medium than investment, hence comes under defensive investments. Savings bank account, term deposits are the common cash investment.
The principal amount is loaned to the bank for a period of time for a predetermined rate of return in the form of deposit. Fixed term deposits are imposed with a penalty or reduced returns when withdrawn before the maturity period. .
You usually get a certificate of deposit or have access to the money itself in the case of a savings account. Cash offers the lowest interest rates of all investment methods but zero risk on principal investment, making it the safest investment.
Though not a highly envied investment option for most, it is considered a vital part of investment diversification due to its low risk and instant accessibility.
The most common fixed interest investment is the government bonds and institutional bonds. Your money is lent to an institution for a fixed rate of return.
In exchange for the money lent, you get a bond as debt security. These are usually fixed and long term. Classified as defensive investment, the return is usually better than Cash but not as attractive as growth investments.
The combination of low interest and long hold period makes it the least opted asset class for individual investors. But institutional investments like retirement funds, and long term investment corpuses majorly rely on bonds for defensive investment in their portfolio.
Shares are the most common of the growth investment due to its high gains and flexibility. Though only 10-15% of individuals in the US have directly invested in the stock market, about 52% have some kind of investment over it through pension funds, mutual funds, etc.
Shares, also known as equity and stock, is owning a micro-part of the company that is publicly traded in an exchange. These equities change in value depending on the performance of the company which means growth of principal, hence classified growth investment. There is no fixed return rate or fixed lock-in period.
Though the risk is high, most companies are growing in the long run averaging a 10% return per annum. Plus owning a share also entitles you for the dividend pay out by the company (Profit passed on to the shareholder).
Investing in shares, though considered high risk, is a viable option to grow faster if you know the game in and out. There are a lot of strategies to diversify your share portfolio alone to maintain a steady growth and mitigate risk.
If you don’t have the appetite for risk or don’t have the time for the foot work, mutual funds, index funds and ETFs might work for you.
Property, or commonly known as real estate investment is a growth investment that has 2 significant money making opportunities – (i) monthly rental income & (ii) Property value depreciation.
Commonly known as high-risk, is one of the reliable investment mediums due to the scarcity of land and ever rising demand. Traditionally, real estate investment is the least explored by individual investors due to its difficulty in finding the best bet and maintaining the property.
But there are other ways you can reap the benefits of real estate without getting your hands dirty. Real Estate Investment Trust (REIT) and Private Equity Real Estate Investment Vehicles are two ways you can invest in real estate indirectly and let them manage your funds.
The large volume of investment and internal diversification helps reduce the risk to great extent. Surprisingly, millennials are showing more interest towards investing in real estate than in shares.
Commodity investing is one of the rarest of the 5 main asset classes. It is directly buying on tangible commodities like gold, silver, oil and agricultural products or purchasing sovereign gold bonds (equivalent to owning gold without the risk of safe storage).
Commodities are mid-high risk depending on the vehicle of investment and has the potential to grow the value invested, hence a growth investment.
One more thing! – Cryptocurrency
Newest of investment medium, the hot topic of government regulatory boards, millenials and get-rich-quick shenanigans is cryptocurrency.
Originally devised to break the central control system (bank, government) in the cash flow and creation is now a money making or losing mine for many. Be warned this can make a fortune of 100x if you choose the right crypto investment. But right now, it has no reason to boom other than the hope of cryptos having a practical use in the near future.
Very high risk and volatile investment but it wouldn’t hurt to put a tiny chunk of your investment that you can afford to lose into some crypto. Be warned, it could be a bubble similar to the “dotcom bubble of the 90’s”.
Now that you understand how each of the investments works, now start accessing the risk-reward ratio and plan your money needs for the coming years to come up with an investment portfolio that will serve you best. Need help in setting up a diversified investment portfolio? We have got you covered.