Beginner’s Guide to The Safest and The Riskiest Investments

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The investment landscape can be very dynamic and, at times, daunting for new investors. The majority of our population prioritizes saving over investment due to the lack of basic financial knowledge. The risk factor that scares potential investors is controllable and dependent on their risk-taking capacity. This is where the concept of an investment portfolio comes into play.

An investment portfolio is a group of assets created by yourself or your financial manager based on your investment, expected output, and risk-taking capacity. The risk factor is directly proportional to higher gains or losses.

The first step to creating a successful investment strategy or portfolio is understanding the asset types and where they stand on the risk factor. The following are some of the most common investment types.

Cash in bank

Cash in banks is the easiest way of saving and investing your money. The investor not only gets to know the exact interest they will earn; they also get the output guarantee by the bank. This method of saving also gives the freedom to liquidate your funds without any penalty. On the flip side, the interest earned by saving money in the bank will never beat inflation.

Investors can also utilize fixed deposit options available with most banks to earn higher interest than a savings account. However, to reap the benefits, one must invest a sizeable amount of money that they would not liquidate before the end of the investment term. Any early liquidation will lead to a penalty levied by the bank.

Bonds

Bonds are issued by corporations or the government to borrow money from the public at a fixed rate of interest prevalent at the time of issuing the bond. Bonds yield a higher interest rate compared to a savings account. The ideal time to purchase a bond is when interest rates are increased by reserve or central banks. A bond can be secured or unsecured.

Secured bonds are issued when the borrower secures the bond with a tangible asset, which acts as a collateral. If a borrower defaults on the bond, the asset is transferred to the bondholders.

Unsecured bonds are not secured by collateral and investors purchase these based on borrowers’ credibility, and credit-worthiness.

Mutual Funds

Mutual funds are investments where more than one investor pools in the money to invest in a portfolio managed by a fund manager. These fund managers define the mutual fund’s investment portfolio and the fund’s riskiness based on the assets they will choose to invest in. The funds collected by the fund manager are invested in stocks, bonds, real estate, derivatives, and other securities.

If you were to invest $1000 in index funds like S&P 500 or NIFTY, you might be able to buy only a handful of stocks for a few companies. However, when you invest in a mutual fund that mimics an index fund, you will be able to diversify your $1000 across hundreds of leading companies. Many funds are actively managed by a portfolio manager who closely tracks the performance and tweaks their investment strategy to derive the best output. However, these funds may have certain maintenance charges which will come out of your interest gains.

Mutual funds carry moderate to high risk based on the fund you chose to invest in. Always read the offer documentation before investing in mutual funds to learn more about,

• Lock-in period — A fixed duration from the investment date during which you may not be allowed to liquidate your investment.
• Exit load — The education that may happen if you withdraw your investment within the minimum investment duration.
• Age & past performance
• Fund manager
• Investment portfolio & risk factor
• Expense ratio — The per-unit cost charged for managing the fund. The lower, the better. The ideal expense ratio should be between 0.5% to 0.75%.
• Fund size — The total value of the fund. The larger, the better.

Exchange-Traded Funds (ETFs)

ETFs are like mutual funds; however, they are traded throughout the day on a stock exchange. Unlike mutual funds, which are evaluated and traded once the market is closed for the day. ETFs’ value will vary drastically throughout the trading window and hence adding a risk factor to the asset.

ETFs are very popular among new and seasoned investors. ETFs can mimic the market trend through index funds like S&P 500, NIFTY, DOW Industrial Index, etc. Investors who are not very keen to research and follow each stock within their portfolio can invest in ETF for an Index fund and monitor the market trend. This allows them to invest in the largest and well-traded companies without the effort to track them individually.

Real Estate

Investment in real estate is not the same as buying a house to settle down in. Investors can purchase commercial or residential properties that can earn a significant upside by collecting rent or resale.

A real estate investment needs significant funding and thus carries higher risks. Real estate investors should amass enough funds to purchase a property without being dependant on a mortgage. Mortgage will significantly reduce your profits and most likely become a liability. Real estate is among the first to get impacted during a financial crisis as it is not an easy asset to sell.

Alternatively, you may buy REITs or Real Estate Investment Trust. They are similar to a mutual fund, where investors pool in money to purchase properties. They trade in the stock market, similar to shares.

Stocks

Stocks are shares of companies traded in the stock exchange every day. These allow an investor to benefit from a company’s success through an increase in share price and dividends. Shareholders can also participate in board meetings, have voting rights, and stake a claim on the company’s assets when a company files for bankruptcy.

Stocks prices are very dynamic and the majority of your return depends on your decision to buy, sell, or hold these shares. Extensive research in a specific industry segment, company or market is essential to make an informed decision. Stocks can yield very high returns and comes with a high risk if the investor is not knowledgeable.

Now that you know about the most common instruments of investments. It is time to build your investment portfolio. Always remember to start with instruments with the least risk and gradually expand your portfolio. Mutual funds and ETFs are good starting points. If you are too busy to monitor your individual investments, it is an excellent strategy to invest in Index funds, which mirrors the market performance. Once you have mastered the mutual funds and ETFs, you may gradually expand your portfolio to stocks, real estate, and other instruments.

Bottom line

• Never invest in an instrument that you do not fully understand.
• It is better to use a financial advisor than let your money sit idle in a bank account.
• Keep your equity at 10% even if you are not willing to take any risk.
• Save at least 30% of your pre-tax income.

This article is for informational purposes only. It should not be considered Financial or Legal Advice. Consult a financial professional before making any significant financial decisions.