Understand the Different Asset Classes

Warren Buffett, the investing legend who’s famously known as the “Oracle of Ohama”, once said in a newsletter to Berkshire Hathaway Inc (NYSE: BRK.B) shareholders, that:

“Investing is often described as the process of laying out money now in expectation of receiving more money in the future.”

But how is this the case? The investment landscape can be very dynamic and is continuously evolving.

For a beginner, investing can be a daunting prospect. This is why I hope our investments for beginners guide will come in handy, especially for novice investors.

The first step to learning about investing is to understand the different types of investment or asset classes based on their relative risks.

This ranges from cash, which is the most stable, to alternative investments, which are generally classified as very volatile.

1) Cash

You are likely to be most familiar with cash. Cash and cash equivalents are short-term, easily accessible or maturing within one-year, low-risk assets.

Among some examples are your physical cash, e-wallet, or bank deposits. For example, with bank deposits, you will earn a certain interest over time.

You’re also guaranteed of your capital. The downside to it is that the interest earned from savings accounts almost never beats inflation.

2) Bonds

A bond is a debt instrument which represents a loan made by an investor to a borrower.

A typical bond usually involves either a corporation or a government agency, where the borrower will issue a fixed interest rate to the lender in exchange for using their capital.

Government bonds are usually seen as lower risk compared to corporate bonds, which usually depend on the rating by credit rating agencies.

Bonds are commonplace in organisations that use them in order to finance operations, purchases, or other projects. Bond rates also have a strong correlation with interest rates.

3) Mutual Funds

Mutual funds are investments where a group of investors pool their money together to invest in various securities like stocks, bonds, money market instruments and other asset classes.

Mutual funds are managed by portfolio managers who allocate this capital based on the fund’s objectives and mandates.

It gives small investors access to a diversified, professionally-managed portfolio at a low entry cost.

For example, an individual with only US$,1000 to invest can buy mutual funds and diversify into 100 different stocks contained within a portfolio.

There are various different mutual funds divided into different categories, representing the securities they invest in.

The risks of these funds varies based on the securities they buy but the risks are lower due to its diversified nature.

Mutual funds are valued at the end of a trading day and, similarly, all buy and sell transactions are executed after the market close.

4) Exchange Traded Funds (ETFs)

ETFs are similar to mutual funds but they are tradable throughout the day on a stock exchange.

In this way, they mirror the buy-and-sell behaviour of the stock market, leading to higher volatility.

ETFs tend to track an underlying index such as the S&P 500 Index in the US or any other “basket” of stocks the issuer or ETF wants to track.

Due to the ease of trading, low cost and broad coverage, ETFs have become increasingly popular of late.

5) Stocks or shares

Investing in the stock market allows investors to participate in the invested company’s success based on the share price movement and through dividends received.

Holders of common stock enjoy voting rights at shareholders’ meetings. Holders of preferred stock don’t have voting rights but do receive preference over common shareholders in terms of the dividend payments.

You may find out more on how to buy shares here: How to Buy Shares: A Beginner’s Guide

6) Alternative Investments

The alternative investment universe is huge and includes everything that does not fall under the conventional investment categories – cash, bonds, or stocks.

Among some of these are hedge funds, private equity (PE) or venture capital (VC), managed funds, art and antiques, commodities and derivatives.

Real estate is also often classified as an alternative investment. In recent years, we have also seen the rise of decentralised finance with blockchain and cryptocurrencies.

The risks tied to such alternative investments are difficult to measure and some of these alternative investments are unregulated by financial statutory bodies.

Finding your investing strategy

There’s no “one-size-fits-all” solution when it comes to investing but the best way to invest your money is to pursue one that fits your personality, based on:

• Your investment style
• Your budget and cash flow; and
• Your expected return and risk appetite

Many experienced investors diversify their portfolio using the different asset classes mentioned and build up their portfolio based on their risk appetite.

A young person might be more adventurous in their investment strategies and opt to invest in the stock market while someone who is nearing retirement age might prefer lower risk investment asset classes such as the bond market.

A good piece of advice for beginner investors is to start with simple investments and then gradually expand their portfolio.

Mutual funds and ETFs are some of the best, and easiest, ways for investors to obtain exposure to a diversified range of investments.

Take it slow

The bottom line is this: Investment is an ongoing education process, and it is important to avoid investments that you don’t fully understand.

Warren Buffett speaks sense when he opined:,

“Rule Number One: Never lose money. Rule Number Two: Never forget Rule Number One.”

And the best way to avoid losing money is not to jump into investments that you don’t understand.

Rely on sound recommendations from experienced and professional investors while dismissing “hot tips” from untrustworthy sources.

The investment journey is an excitement and rewarding process as it builds your wealth sustainability over time.

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