You may have heard the phrase “Money doesn’t grow on trees” before. I used to think the same too.. until I realised that money can be grown on trees, and the tree is sown with the seeds of assets and investments.
After you plant the seed, you should start nurturing it by adding more assets and investments. You can do this by allocating a part of your monthly salary or commission to the original investment.
The higher the tree grows and the bigger it gets, the better will be the fruit from it. Let’s call this tree with the name “Financial freedom”.
I have written a previous post on where to save money, listed 5 places where you can save money in.
But, saving money alone may not bring you financial freedom. This is because the interest rate received on your savings is lower than the rate of inflation. Instead of keeping the money you do not need in the near term, you should start considering investing it. Depending on your comfort level of risk, you can choose the right investments for you.
Different investments have various expected rates of return, related to the risk involved. Investments are also classified into different asset classes.
What is an asset class?
An asset class is a grouping of similar assets that share the same characteristics. These are also subjected to the same regulations.
Stocks, Fixed Income, Real-estate, Derivatives, Cryptocurrencies are some of the asset classes traded.
Diversifying your portfolio with different asset classes is always a good idea. Let me explain some of the basics of the asset classes below.
Stocks
Stocks are also called equity, these are part ownerships of a company. When a company is listed and traded on an exchange, you can buy and sell it on the exchange using a brokerage account. In the past, setting up a brokerage account and buying and selling was difficult. In the era of the internet and smartphones, these activities become easy as ordering food online.
You can potentially profit from equities either through a rise in the share price or by receiving dividends. Stocks are often categorised by market capitalisation into small-cap, mid-cap, and large-cap stocks.
When you pick a stock, it should be after you have done enough research on their business model, how they make money, profitability etc… All these attributes will determine whether it is a good investment or not.
There are mutual funds and ETFs (Exchange Traded Funds) that allow you to choose a basket of Stocks/Bonds.
I will write in-depth about investing in stocks and link it here in the future.
Bonds/Fixed income
Investing in fixed-income securities, such as bonds or other debt securities, provides a rate of return in the form of interest. Investments in fixed income assets are generally considered less risky than in equities or other asset classes.
As the name suggests, this is fixed income, the returns are based on a pre-determined rate. These interest payments are called coupon payments and these are paid at fixed intervals until maturity.
While bonds are considered safer than stocks, there is a possibility that the issuer of the bond default on payments.
Bonds can be further classified as government bonds and corporate bonds. Government bonds are issued by governments, Corporate bonds by companies that wish to gain access to funds.
Cash and Cash equivalents
Cash and cash equivalents are suitable for short-term investing. The primary advantage of such investments is their liquidity. Thus, money invested in cash and cash equivalents is easily accessible. Example of cash equivalents includes treasury bills and commercial papers with a short-term maturity date of three months or less.
Real Estate
Investing in real estate means purchasing property as an investment to generate income rather than using it as a primary house. Generally, it is understood to be any land, building, infrastructure, or other tangible property, usually immovable, although ownership rights may be transferred.
Since real estate transactions take some time to take place, it is often considered non-liquid asset. Compared to stocks – which you can buy and sell on the same day, real estate transactions take time and more formalities.
Real estate properties are divided into residential, commercial, retail, land etc… Each of them has its own specialities and characteristics.
Derivatives
Derivatives are financial instruments that are based on, or derived from, an underlying asset. These include futures contracts, spot and forward foreign exchange, options, and other financial derivative instruments. For example, stock options are a derivative of stocks.
These contracts themselves do not have any value, value is derived from the underlying asset. In the case of an option contract, the price of the contract will go up and down based on the stock price.
Cryptocurrencies
Cryptocurrencies are the latest addition to investing and trading. Their price is volatile since demand and supply determine the price. Some cryptocurrencies have a predefined supply. Hence, it depends on demand.
Cryptocurrencies are decentralised and are not backed by governments as a legal tender except for bitcoin in El Salvador.
Summary
Below is a summary of the above-mentioned asset classed by their risk and return potentials. This may help you get an understanding of what suits you. As always, not every option is suitable for everyone.
Asset class comparison
Conclusion
I hope I was able to give you an idea about the characteristics of different asset classes, the risk and potential rewards associated with them. More details and pros and cons of each of these asset classes will be shared in the coming blog posts!.
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Invest safely 😀