Jun 10, 2022
Grant Murphy
Building a diversified investment portfolio exposes an investor to a variety of asset classes. In this article, we delve deep into the different types of investment tools. The aim is to help both novice and seasoned investors expand their knowledge and make sound investment decisions.
Understanding Asset Classes
Simply put, an asset class is a group of investment vehicles that behave similarly and are subject to the same laws and regulations. The broad categories are equities, bonds, real estate, and mutual funds.
1. Equities
Equities, also known as stocks or shares, represent ownership in a corporation. By investing in equities, not only do you become a part owner of the corporation, but you also stand to benefit from dividends and capital gains if the company performs well. Conversely, if the company does poorly, you could also suffer losses.
2. Bonds
Bonds, on the other hand, represent debt obligations. Essentially, a bond is a loan provided by an investor to a borrower. The borrower can be a corporation or the government. Investors earn through the interest payments made by the borrower. Bonds are generally considered a lower-risk asset compared to equities.
3. Real Estate
As an asset class, real estate involves investing in physical property. This could be residential, commercial or industrial property. Returns from real estate come in the form of rental income and appreciation of property value over time.
4. Mutual Funds
Mutual funds are a type of investment vehicle made up of a pool of money collected from various investors to invest in different asset classes. A mutual fund allows investors to diversify their portfolio without having to individually buy each security.
Benefits of Diversification
Diversification is necessary because it allows risk spreading. By not putting all your eggs in one basket, you protect yourself from severe financial loss in case a particular investment doesn't pay off. Diversification also allows for the successful elements in your portfolio to potentially offset any underperforming ones. Thus, diversification can increase the overall return on investments while minimizing risk.
Conclusion
Investment diversification is an effective strategy to maximize returns and minimize risk. Understanding different asset classes and their behaviour is the first step towards building a diversified portfolio. Each asset class carries a different level of risk and has its potential returns; therefore, your choice of asset class should align with your risk tolerance and investment goals.
As always, it is recommended to consult with a financial advisor before making any major investment decisions.
Investing involves risks, including loss of capital, illiquidity, lack of dividends and dilution, and should be done only as part of a diversified portfolio. Please read the Risk Warnings before investing. Investments should only be made by investors who understand these risks.