Investing: Where To Put Money To Work — AAX Academy
The investment landscape is vast, dynamic and always evolving. It’s important for investors just starting out on their journey to understand the basic principles underpinning each asset class and how they relate to each other in terms of risk. From there, you can develop a trading plan that diversifies the portfolio according to personal goals, motivations, personality and risk appetite.
Below you’ll find an overview of the major asset classes, in ascending order of risk.
Depositing cash in a savings account is probably the most easily understood and predictable investment method. You can calculate the gains over any period of time with the annual interest rate provided by the bank of your choice. There could be penalties involved if you need to take out cash before the agreed upon time limit expires, but generally you can count on getting your capital back with some additional gains.
However, the interest earned from cash in savings accounts rarely outperforms inflation. Typically, inflation hovers around 2% or just below, and the majority of interest rates do not exceed that number. In other words, the longer you keep large amounts of money idle in the bank, the lower its value in the long run. Most financial advisers will say it’s good to keep a portion of you wealth in cash for fast and reliable access, but diversifying into other asset classes is the way to increase the value of your entire portfolio.
Bonds, or Treasuries in the US, are debt instruments representing a loan typically made by a corporation or government agency in order to finance operations, purchases or large-scale projects. The bond issuer will make interest payments at scheduled intervals, leading up to the maturity date at which point the principal amount must be paid back in full or risk default.
Although floating rates have become more commonly used in recent years, bonds are referred to as a fixed income instrument because the borrower will issue a fixed rate to the lender in exchange for using their capital. Because rates are essentially determined by interest rates, bonds are more heavily traded during periods of quantitative easing or when central banks raise rates.
This type of investment vehicle involves multiple investors pooling their money together, in order to buy into a range of securities. Funds are managed by portfolio managers who distribute the invested capital across stocks, bonds and other securities in line with the prospectus detailing the investment approach of the fund. As such, there are many different types of mutual funds that offer varying degrees of risk and yield.
Mutual funds are of particular interest to investors who do not have the time or knowledge to take an active approach towards investing in a well-diversified manner and prefer to outsource that part of the work to a fund manager. However, that convenience does come with yearly management fees and front-end charges that can eat into the returns an investor makes.
Exchange Traded Funds (ETFs) are similar to mutual funds, with the biggest difference being that ETFs are actively traded on stock exchanges. As such, they resemble the buy-and-sell dynamics of stocks with considerable price fluctuations throughout the trading day. But despite that, what investors buy in ETFs couldn’t be more different from stocks. Whereas a stock is a stake in a single company, ETFs offer instant diversification across a large number of assets.
ETFs often have a certain ‘theme’ that provides direction for the types of assets that are included in the fund’s holdings. There are ETFs that mimic the price movements of an index such as the NASDAQ, only buy companies that derive most of their revenue from the sustainable and renewable energy sector, dab in the fledgling marihuana industry in the US, go big on all things Fintech, plug in to the world of gaming, and much more.
Costs are generally lower compared to mutual funds, but volatility is higher.
Arguably the best known and understood investment asset, owning shares of stock lets you participate in the success of a business as the stock’s price increase and/or dividends are paid out.
While the investment vehicle is pretty straightforward, knowing what stocks to buy is the tricky part. You need to understand how to value a stock, delving into underlying economics, technical analysis, and the business opportunity at hand. Stock picking is hard, and few get it right. Plus, for the sake of diversification it makes sense to hold more than just a few stocks, so you need to pick a range of stocks you feel confident will meet your financial goals.
The foreign exchange (Forex) market is one of the largest in the world, open 24/7 with an average trading volume of $5 trillion. Most trading activity involves the major currency pairs tied to the world’s largest economies including USD, JPY, GBP, EUR, CHF, CAD, AUD and NZD. The fundamentals that move the forex market include a wide range of factors that are all slightly different between currencies but usually involve data about the state of a nation’s economy, central bank policy changes, and changes in the political landscape.
While forex trading is fairly straightforward, it is not really the realm of long-term investing. Currencies fluctuate drastically on a single day, and the stronger currency within a trading pair will switch all the time. Few forex traders would hold a 5-year position going long on USD in the EUR/USD market — that essentially just means you’re holding cash. Instead, forex traders rely on technical analysis to determine entry and exit price points to make gains within their forex trading strategy.
Cryptocurrency is infamously volatile, presenting lucrative trading opportunities but also considerable risk. With superior gains compared to all asset classes mentioned above, it’s no surprise that more investors are including crypto in their portfolio. Of course, given the high degree of risk, the amount allocated to crypto should be carefully considered to ensure the broader exposure across your portfolio remains in line with your investment goals and risk appetite.
Within crypto, there are many different types of assets including BTC, ETH, DOT, XRP, ADA and many more. There are different dynamics at play to consider before investing into any of these crypto assets.
BTC is trading at a significantly high price looking at historical charts, so you need to develop a long term view of Bitcoin and determine what your entry position should be. ETH is tied to a whole sector of crypto with smart contracts and DeFi, therefore it makes sense to research the world of DeFi before buying into the coin. DOT is a Web3 project, which could potentially usher in the next generation internet drastically changing the way culture is created, information is distributed and data is owned.
Where to go from here
From cash to crypto, there is an investment asset for every type of investor and all risk appetites. It’s all about developing your own plan, diversifying well to manage risk, executing the strategy, and constantly reviewing performance to adapt to changing market conditions.
Originally published at https://academy.aaxpro.com on January 21, 2021.