Investing your savings is the next step in reaching financial success. It is a huge step because of the size and scope of investing in today’s markets. The financial industry has created a massive amount of different products to choose from with complicated fee structures and high levels of risk.
I am going to begin with a three part series on setting up an investment portfolio.
This week’s lesson is on ASSET CLASSES.
An asset class is simply a grouping of similar types of investments. The three most common assets classes are: Equities (stocks), Fixed Income (bonds) and Cash (cash equivalents). We need to categorize them in even greater detail. Each of these can be broken down into sub-classes by size, industry, location, risk etc
- Location – domestic market, foreign developed markets, (like Europe or Japan) foreign emerging markets (like India or China)
- Market capitalization – how big is the company (small-cap, mid-cap, large-cap)
- Domestic or multinationals- does the company’s revenue come from one country or from around the world
- Value or growth- Is the company well established with predicable revenue or is it new with lots of potential
Fixed Income / Bonds
- Government or corporate bonds
- Foreign or domestic
- Investment grade or high yield (junk bonds)
- Time of maturity- short term (under 3 yrs.) mid-term (up to 7yrs) long term (10 yrs. & longer)
- Bond like – preferred shares, convertible debentures
- Other – mortgage back securities, commercial paper, multitude of interest paying products
Cash / Cash equivalents
- Savings accounts
- Canada Saving bonds
- Treasury bills
- Guaranteed investment certificates (GIC)
- Money market mutual funds
Alternative investments are another asset class for sophisticate or high net worth investors. The following are just a few examples;
- Real Estate
- Commodities – natural resources like oil & gas, agricultural like wheat & corn, metals like copper etc
- Precious metals – gold & silver
- Stock Options
- Future Contracts
Determining which assets to hold in your portfolio will depend largely on your time horizon and your ability to tolerate risk.
An investor with a longer time horizon, like saving for retirement, may feel more comfortable taking on riskier investments. (More stocks than bonds) By contrast, an investor saving to buy a house would likely take on less risk because they have a shorter time horizon. (Short term bonds & GICs)
Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An aggressive investor is more likely to risk losing money in order to get better results. A conservative investor tends to favor investments that will preserve their original investment.
Next week’s lesson: Asset Allocation