To begin investing, we should start by familiarizing ourselves with the different investment asset classes and the differences between them. The 4 investment asset classes are Stocks, Fixed Income, Real Estate and Alternative Investments. Most other investments such as unit trusts / mutual funds, ETFs, options etc. have an underlying asset which is one of the 4 basic classes.
The reasons everybody should be familiar with all the classes are so that they know what options they have when it comes to investing, what asset classes are suitable for them, how certain asset classes may help to diversify the portfolio and improve risk/reward ratios and more.
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Most people are familiar with stocks / equities / shares in general. The stocks represent a partial ownership of a business, be it public listed on a Stock Exchange or privately held. The shares can be classified into Common Shares (Class A/Class B), Preferred Shares and Restricted Shares. Most investments would be in either common or preferreds while restricted are generally given to employees as an incentive to hit certain targets.
Investments in stocks allow investors to take part in solid, blue chip businesses or exciting growth business opportunities depending on their investment criteria. Common shares allow investors to share in the business upside through dividends and capital appreciation of stocks. Preferred shares are more similar to fixed income in that they do not share the upside, but get a fixed dividend payout as stated on issue.
Fixed income instruments provide a certain level of income, normally by way of interest payments to the investors. There are many forms of fixed income instruments including but not limited to sovereign bonds, municipal bonds, Treasuries, corporate bonds, perpetual bonds and more.
Investors in fixed income become lenders to the issuer under the terms of the bond indenture. The issuers may be governments, statutory boards or corporations who borrow money to finance their activities such as business expansion, building of infrastructure and so on. There is usually a fixed maturity date on which the issuers will return the full principle of the borrowed amount. During the tenure, investors may also receive interest payments, much like how banks charge borrowers interest.
The reason for investing in fixed income is that apart from the fixed coupon payments, bonds tend to be negatively correlated to stocks. In a simple sense, when stocks go up, bonds go down and vice versa. Therefore, they are a very good diversifier for a portfolio which is heavy in equities. In general, bonds can be classified into either investment grade (BBB and above) or junk/high yield (below BBB). The higher the grade, the lower the interest rates.
Real estate can be classified into different sub classes based on usage, including raw land, agriculture, residential, retail, office, industrial and healthcare. They can also be further classified based on build up i.e. landed – terraces, semi-detaches, bungalows; low rise – apartments, condos, ramp up industrials; high rise – apartments, condos, offices, shopping malls etc.
Real estate prices may not fluctuate as wildly as stock prices, however, real estate prices do follow market cycles which are generally preceded by huge booms and busts in the stock market. One of the key benefits for real estate investments is the ability to take on high leverage with bank financing. While the returns are much higher, there will also be higher risks. Certain investors may also take comfort in owning a physical asset as opposed to stocks and bonds. Compared to stocks and bonds which could become potentially worthless, real estate values should never become zero. There will always be a value for real estate as long as there is still proper legal governance and an active market.
Alternative investments is the catch all for any other investments which is not classified under the above 3. They include investments like hedge funds, venture capital, private equity, commodities, derivatives, collectibles and more. The assets in the alternatives class however do require very specialized knowledge as compared to the other 3. For example, you should be very well versed in art if you intend to invest in art pieces. Most alternatives generally tend to have much higher risks and the returns can be quite difficult to gauge.
About the Author
Calvin Yeo is the Managing Director of Doctor Wealth Pte Ltd (www.drwealth.com), which is an online financial planning platform. He is also a Chartered Financial Analyst (CFA) as well as Certified Financial Planner (CFP).
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