To invest means to allocate money in different assets with the expectation of some monetary benefit from it in the future. Basically there are two ways to make money: By working and/or by having your assets work for you. You can pick from a variety of asset classes depending on your risk taking capacity. It is said that, Higher the risk, higher is the returns.
The video below explains what asset classes are and what are the different types of asset classes:
In the above video you can see how one must cover all types of asset classes while investing, because each one serves a different purpose, and while you make losses in some, you can protect yourself by making profits in another.Here’s is a summary of the video:
There are 4 types of asset classes:
1. Cash Equivalents: Hard cash disposable to you
All the hard cash available with you forms this asset class. So your savings a/c, current a/c, money in digital wallets come under the ‘cash equivalents’ asset class. These may or may not fetch any returns and even though they do the returns (4%-7%) are negligible. This asset class is required for emergencies and daily purchases that you need to make. After accounting for emergencies and daily purchases the remaining can be invested in the remaining 3 asset classes.
2. Fixed Income: Investments giving fixed and assured returns
All investments giving fixed returns can be clubbed under the Fixed Income’ asset class. These include bonds, debentures, fixed deposits and other such debt instruments. Most debt instruments are forms of loans given to a government or a company that earn you a fixed interest and on maturity the principal sum is repaid back.
Since these investment options offer promised returns and usually have longer maturity periods (up to 20 years) they are less risky compared to equity. In short think of investing in fixed income asset class as lending your money to someone for a period of time.
Although this asset class is safe the returns (average return 5%-12%) aren’t enough to keep up with increasing prices (which means they don’t beat inflation). So over time your amount will grow but it will not beat inflation That’s why this asset class is to PROTECT YOUR MONEY and not exactly GROW IT.
2. Equity: Investments denoting ownership in a company or asset
Investments that denote ownership in a company or an asset form the equity asset class. Let’s say you own 100 shares of Wipro, this means you have equity in Wipro. Now if wipro does well you make a profit, and if it doesn’t you make a loss. This makes returns on equity volatile and risky. But at the same time they are higher than the fixed income asset class and range between 12%-18%.
To make substantial profits in equity you need to keep your money invested in them for a long time (usually between 3-10 years) since companies take a while to grow. But few people even invest in them on a short term basis (less than a year). This is almost as risky as betting, because of how sensitive share prices are. So only indulge in this if you’re confident and an experienced stock market investor.
If you’re just going by the number, stock markets seem like a great bet. But be warned, it takes lots of time and research to select the right companies to invest in. So another easier alternative is investing in the markets through Equity Mutual Funds. This is an indirect way of investing your money in equity and its safer.
4. Alternate Investments: Apart from cash, fixed income, and equity all other investments come under the ‘alternative investments asset class’. This covers the following:
- Real Estate: Any investments made in property like a house, office plot, farmhouse etc. comes under real estate. These are more like one time investments that usually appreciate in price. But they might not always sell making this investment less liquid- Liquid means converting it into cash. The investment amount for real estate is also very high unlike stocks and fixed income where you can invest amounts as low as Rs. 1000. Real estate market has cycles of ups and downs and returns range from 14%-15%. Real estate returns also depend on factors like government policies, economic conditions, political situations, etc.
- Commodities: Commodities refer to physical goods or products that have a resale value. Examples are Gold, Silver, Copper, Rice, and Oil. The prices of these products depend on demand and supply in the market and people don’t invest in them for a long term. Commodities like oil are usually traded while commodities like gold and silver are used for ornamental purposes. These aren’t the ideal investment options but when prices rise they also rise in price. So they serve as a hedge against inflation.
Apart from these there are other alternatives like stamps, coins, paintings, in which people invest but the returns are relatively low compared to the traditional asset classes mentioned above.
The table below captures the 4 types of asset classes along with their returns, risk, liquidity and frequency of investment:
From all the above asset classes to pick the one that suits you ask 4 questions:
- What are you investing for? Example: If you’re investing for your child’s education invest in safe fixed income securities. But if you’re investing for a car you can invest in equities.
- How much risk can you take?
- Are you a one time investor or prefer investing in installments?
- Will you to encash your investment often? If yes then pick the medium-high liquid options. If No then pick the low liquid options.
Using these questions and the chart above you can easily decide whats best for you. If you have any other queries regarding asset classes, comment and let us know.