If you are just starting out in creating an investment portfolio you will first have to understand some basic concepts about the financial markets. One of these concepts is learning about the different asset classes available to you as an investor. Each asset class will have its own particular characteristics, risk level and potential reward. Here are some of the basic asset classes, in order of lowest to highest risk.
Most people have a pretty good idea of what cash in a bank account is all about. For investment purposes, you should know that cash is one of the least risky types of assets to hold in your portfolio. Although interest earned on cash deposited into a bank account usually is less than the rate of inflation, the advantage is that you have a good idea of how much interest you will be earning. Of course, a bank account offers practically a guarantee you will at least be able to receive your deposited money back.
Certificates of deposit
Another asset type which is similar to cash is certificates of deposit (CDs). However, the advantage of CDs over cash is that CDs usually have higher interest rates. Now, the disadvantage compared to cash is that CDs will charge you a fee if you withdraw your funds before a specified period of time.
Corporations and governments will issue bonds which are another type of investable asset class that are essentially loans investors will make to the issuing entity. As an investor, you are promised interest payments as well as your initially invested funds returned to you. Bonds usually pay you higher interest rates than you would usually earn with a cash deposit in the bank. On the other hand, you should be aware that bonds are riskier, since there is a possibility of the issuing entity not being able to pay back the loan for one reason or another.
Managed by financial professionals and experts, mutual funds are essentially more than one investor pooling together money for purposes of investing in a variety of stocks, bonds, and other securities. Usually with as little as $1,000 you will be able to invest in a fully diversified portfolio of financial instruments.
Exchange traded funds
You may also be able to invest in a diversified group of assets, similar to mutual funds, through investing in exchange traded funds (ETFs). An ETF is basically a bundle of curated assets which you can invest in with a single market position. However, unlike mutual funds, ETFs are not actively managed by portfolio managers. Instead, an ETF is designed to track the economic performance of a specific geographic region or industry sector.
If you are looking to invest in a specific company, you can invest in the company’s stock if it has issued shares on the public market. Shares of stock represent ownership of a company that is proportional to how many of the total shares issued that you own. Stock shares will appreciate in value as the economic performance of the company increases. You may also be issued dividends which are cash payments from the company. However, stocks do tend to have more risk than other asset classes, such as bonds and cash.
Customize your portfolio
These are just a few of the available asset types that you can select for your investment portfolio. There are alternative assets, which tend to be riskier, such as commodities, real estate, private equity funds and hedge funds. However, the most important thing is to customize your portfolio with your risk tolerance and family financial planning goals in mind.