Introduction to Investing: A Beginner's Guide

Investing can be complex and constantly changing, but those who educate themselves on the fundamentals and different types of assets have a better chance for long-term success. Understanding the level of risk associated with various investments is crucial.

Understanding the Investment Risk Ladder

Here is a breakdown of the major asset classes, arranged in increasing order of risk, on the Investment Risk Ladder:

Cash

Cash bank deposits are the most basic and secure investment assets, as they provide a clear understanding of the interest earned and guarantee the return of the initial capital.

However, the interest earned on cash in a savings account usually does not keep pace with inflation. Certificates of deposit (CDs) offer higher interest rates than savings accounts, but they come with less liquidity and may have penalties for early withdrawal.

Bonds

Bonds are debt securities that represent a loan made by an investor to a borrower, such as a corporation or government agency. The borrower agrees to pay a fixed rate of interest to the lender in exchange for the use of the borrowed capital. Bonds are commonly used by organizations to finance projects, operations, or acquisitions.

Bond yields are closely tied to interest rates, which is why they are actively traded during times of monetary policy changes such as quantitative easing or interest rate hikes by the Federal Reserve or other central banks.

Mutual funds

Mutual funds are investment vehicles in which multiple investors pool their money to buy securities. They are actively managed by portfolio managers who invest the pooled funds into various stocks, bonds, and other securities. The minimum investment for most mutual funds ranges from $500 to $5,000, but many don't have any minimum at all. Even a small investment can provide exposure to a large number of stocks through a single fund's portfolio.

Mutual funds can track underlying indexes such as the S&P 500 or Dow Jones Industrial Average, or they can be actively managed by portfolio managers who adjust the fund's allocations. Actively managed funds typically have higher costs, such as annual management fees and front-end charges, which can affect an investor's returns.

The value of mutual funds is determined at the end of the trading day and all buying and selling transactions are processed after the market closes.

ETFs - Exchange-Traded Funds

Exchange-traded funds (ETFs) have gained popularity since their introduction in the 1990s. ETFs are similar to mutual funds but they are traded on a stock exchange throughout the day, similar to stocks. This means that the value of ETFs can fluctuate significantly during the trading day.

ETFs can mirror the performance of an underlying index, such as the S&P 500, or a specific basket of stocks chosen by the ETF issuer. This can include a diverse range of markets, sectors and commodities. ETFs are popular among investors because of their ease of trading and wide range of options.

AMCs - Actively managed certificates

Actively Managed Certificates (AMCs) are structured financial products that enable active management of investment strategies through an index. They allow investment managers to quickly and easily launch a specific investment strategy with a reduced time-to-market of a few weeks. AMCs have gained popularity in recent years for their combination of the benefits of structured products with the flexibility to adjust components of the underlying. Unlike investment funds, they can be structured quickly and cost-effectively, making them a preferred choice for launching investment strategies.

Actively Managed Certificates (AMCs) are derivative securities, which means they are not collective investment schemes but rather securitized portfolios that are actively managed by an investment manager. They can be issued as on- or off-balance sheet certificates and can be privately placed or listed on an exchange. Each AMC is linked to a separate underlying security with its own ISIN number. The global AMC market has assets under management exceeding $1 trillion, with the strongest growth seen in the last three years. These products can be known by different names depending on the jurisdiction, such as Exchange-Traded Notes, Dynamic Equity Notes, Strategy Notes, Strategy Index Certificates, and Actively Managed Trackers.

Stocks

Stock ownership gives investors a stake in a company's performance, through stock price appreciation and dividends. Shareholders have a claim on the company's assets if it is liquidated, but they do not have ownership of the assets.

Holders of common stock have voting rights at shareholders' meetings while holders of preferred stock do not have voting rights but receive priority in terms of dividend payments over common shareholders.

Alternative Investments

Real Estate

Investors can invest in real estate by buying commercial or residential properties directly or by purchasing shares in Real Estate Investment Trusts (REITs). REITs operate similar to mutual funds where a group of investors pool their money to purchase properties and are traded on stock exchanges.

Hedge funds

Hedge funds invest in a variety of assets with the goal of producing returns beyond market returns, known as "alpha." However, performance is not guaranteed and hedge funds can experience significant fluctuations in returns and underperform the market. Typically, hedge funds are only available to accredited investors and require high initial investments of $1 million or more, and may impose net worth requirements. The investment in hedge funds can also lock up the investor's money for substantial periods of time.

Private equity funds

Private equity funds are investment vehicles similar to mutual and hedge funds, where a private equity firm, known as the "adviser," pools together the money invested by multiple investors and makes investments on behalf of the fund. They often acquire a controlling interest in operating companies and actively manage them to increase their value. Private equity funds can also target fast-growing companies or start-ups. Like hedge funds, they tend to focus on long-term investment opportunities of 10 years or more.

Commodities

Commodities refer to physical resources such as gold, silver, crude oil, and agricultural products. There are various ways to invest in commodities, such as through a commodity pool or "managed futures fund", which pools money from multiple investors to trade in the futures and commodities markets. This limits an individual investor's risk to their financial contribution to the fund. Some ETFs are also specifically designed to invest in commodities.

How to Invest Sensibly, Suitably, and Simply

Experienced investors often diversify their portfolios by investing in a mix of the asset classes listed above, tailored to their risk tolerance. A common piece of advice for investors is to start with simpler investments and gradually expand their portfolio. Mutual funds or ETFs are often recommended as a starting point, before moving on to individual stocks, real estate, and other alternative investments.

Many people don't have the time to constantly monitor their portfolios, therefore, investing in index funds that mimic the market is a practical solution. Steven Goldberg, a principal at Tweddell Goldberg Wealth Management and a long-time mutual funds columnist at Kiplinger.com, suggests that most individuals only need three index funds: one for the U.S. equity market, another for international equities, and a third for a broad bond index.

What Are the Different Asset Classes?

Traditionally, the three main asset classes are equities (stocks), debt (bonds) and money market instruments. However, in recent times investors may also consider assets such as real estate, commodities, futures, derivatives, or cryptocurrencies as separate asset classes.

Which Asset Classes Are the Least Liquid?

Real estate and land are typically considered as some of the least liquid assets as it may take a while to buy or sell a property at market price. On the other hand, money market instruments are considered the most liquid as they can be sold for their full value easily.

Conclusion

Obtaining a proper investment education is crucial and it is important to avoid investing in assets one does not fully understand. Trustworthy recommendations from experienced investors should be sought after and "hot tips" from unreliable sources should be ignored. When seeking advice from professionals, it is recommended to consult independent financial advisors who are paid only for their time, rather than those who earn commissions. Above all, diversifying one's holdings across a wide range of assets is important.