Asset Classes And Investment Vehicles
In the beginning of my investment learning journey, I always thought that investment vehicles and asset classes mean the same thing, and I actually thought so for quite some time. However, a part of my mind kept feeling bothered by the two terms that keep on appearing as you read more and more. Surely, there must be some differences, otherwise a popular site like Investopedia will not have two different articles for these two different terms.
Sure enough, my confusion was gone when I finally understood them. So, this article is another supposed beginner friendly article to guide you who are new or who want to better understand asset classes and investment vehicles. Also, if you haven’t yet, you can check out my other article on what to do before you start investing.
P.s. I am by no means a professional as I am just a software engineer who is into investment.
Seriously, why would there be so many terms? Just kidding, who am I to say so when the same thing is also applicable in the world of programming. 😋
By definition, an asset class / type is like a grouping of investments that act similarly in the marketplace. Think of it like a category, I would say. If by definition an asset means a valuable thing, an asset class is like a category of valuable things. Well of course, in finance, it has to sound much better with all the proper terms combined.
It is said that it has been a debatable topic on what is considered as an asset class, which I would say is pretty much true because I could not really find a complete list of asset classes. However, there are definitely a few that are commonly known as part of asset classes.
Here are the known asset classes:
- Equities
- Fixed income
- Cash and cash equivalents
- Real estate
- Commodities
- Currencies
- Alternatives
I believe at least you would be familiar with real estate or currencies. However, not to worry, after explaining about investment vehicles, you would have a bigger picture.
Meanwhile, by definition, investment vehicles are like the ways or methods that investors use to invest to grow their money. So it’s like a vehicle that you can choose to grow your money in. Investors typically might have more than one for the purpose of not over-concentration. These investment vehicles, however, can be further categorised into a low-risk type and a high-risk type.
Here are some of the examples of investment vehicles:
- Stocks
- Bonds
- Funds
- REITs
- Options
- Futures
So as you can see, you probably might have heard at least one of the above mentioned ones especially after the pandemic happened. It is literally a means for you to grow your money and eventually, they make up your portfolio.
Of course there are more of those investment vehicles. However, we can start to see that investment vehicles are like part of asset classes in which you can say that asset classes are groupings of investment vehicles.
Asset Classes
So, an asset class / type is like a grouping of investments that exhibit similar characteristics. It is said that there is usually little to no correlation between each asset class. As such, people would try to diversify their assets so that their risks are spread out. This is because each of them have different levels of risk and return, of which they will behave differently over time.
1. Equities
Equities are also known as stocks or shares, which you probably have heard a lot about since the pandemic happened.
So, what’s the deal then? When you buy an equity, you basically become like a co-owner or a shareholder (which is more commonly mentioned) of that issuing company.
For example, let’s say there is a company A who has a total of 1 million outstanding shares and you purchase 500,000 of the shares, you own 50% of the company. Unfortunately, unless you are a rich person like our big brother Warren Buffett, it is very hard to own like 2% of a big company like Apple.
Having equities, you usually get returns in two ways: capital gains or dividends.
Capital gains refer to when the stock price of the company increases, you gain some profit and when you sell it, that profit is yours. For dividends, some companies pay part of their earnings as dividends back to their shareholders. Since you own part of the company no matter how small, you are entitled for the dividends as well.
2. Fixed Income
This term doesn’t make sense to me initially. Why would an asset class be called a “fixed income”? An income that’s fixed?
Well, it turns out that it is the type of investment security that pays investors fixed interest or dividend payments until its maturity date. The borrower or issuer is obliged to pay a fixed amount on a fixed schedule. Bonds basically fall under this.
For example, the borrower may have to pay interest at a fixed rate or interest once a year or twice a year and repay the principal amount on maturity. This means that the original principal will be returned fully once it reaches the deadline. Bonds work similarly as well.
One thing to take note is that when a company goes bankrupt, fixed-income investors are paid first than the stockholders.
A more generic term for bonds is debt securities. An issuer that needs to raise funds from a lender would release debt securities.
Another thing to take note is that as much as this is considered low risk, it does not mean there is no risk.
3. Cash and Cash Equivalents
Just like the name suggests, cash simply means the cash that is sitting in your savings account in the bank or that is currently in your wallet.
What about cash equivalents? They are securities that can be easily converted into cash and also can still earn you a bit of money.
With that said, cash typically doesn’t really earn you anything or appreciate in value but perhaps it still has values when you compare it with other currencies or the rate movements. As such, people always say your cash will only depreciate in the long term due to inflation. Inflation has the role to erode real values of any investment over time.
So, that in itself already reveals the first risk of cash: inflation. The second one is when you put the cash in a bank, it is similar to lending the bank money, which in turn makes it a risk. The risk is when the bank cannot pay you your money back or something happens to the bank and your money just goes missing that you cannot withdraw. Any form of debt that has a loan term of one year or less is considered a cash equivalent.
Sometimes, there are also news reports who would say things like companies are sitting on cash. This means that the companies are having a lot of cash invested in cash equivalents. This is because banks simply cannot give you much earnings (the rate is just too small). At least cash equivalents are still better.
4. Real Estate
Yes, usually when people say real estates, they mean properties. If you own a house, you already have exposure to real estate. However, it does not mean only residential property like your house. There are also others like commercial or offices, retails (shops), and industrial and logistics (warehouses). These properties can perform quite differently from the investment perspective.
The ways of making money are similar to stocks. There are two ways: selling it for profit when the price shoots up or collecting rental income. Sometimes rents can increase as well which will increase your income too.
However, this asset is the most capital intensive. You need a lot of cash. Banks can lend you money to buy properties but not a lot of banks would do so. You still can earn though, as long as the cashflow from your property pays your monthly mortgage which means you still can enjoy the benefits of owning property. This is somewhat called leverage too.
What if you do not have a lot of money in the first place? You can consider REITs which are considered like stocks. A REIT is definitely cheaper and more affordable than owning a property.
5. Commodities
It is what you think it is. A commodity is a basic good that often becomes an input to produce other goods or services. It is said that owning commodities is a hedge against inflation. Commodities typically do not trade in tandem with equity and bond markets.
Commodity prices typically rise when inflation accelerates which explains why investors often flock to them for “protection”, especially during unexpected inflation. Also, when the demands for goods and services rise, this also means the prices for commodities might increase. It is like when the demand for oil suddenly increases, the price for that commodity is expected to rise.
So, some people do invest in commodities like gold, iron, wheat, oil and timber. However, they do not pay you an income. In fact, some of them cost you money to hold, so people invest in them with the hope of making capital gains. The prices of physical commodities can be quite volatile and unpredictable so this is usually seen as a high risk investment.
6. Alternatives (Others)
There are also others that are considered as alternatives, which I personally feel that I can do so if I have deep pockets. You can consider investment into things like luxury watches or designer bags which I believe you would have heard of.
Art, coins, stamps, gold, platinum, fine wines, and exotic or limited edition cars are all considered alternatives. This is because they can hold their values against inflation and rich people do have some of these as part of their assets. Besides, these items might appreciate in value in the longer term.
Of course, recently, cryptocurrencies also got the spotlight and how some people became millionaires just like that. They are said to fall under alternatives as well as they are said to be a good hedge just like gold.
Investment Vehicles
Investment vehicles refer to any method by which people can invest to, ideally, grow their money. Therefore, they are the vehicles that investors use to try to gain positive returns on their money.
Now, of course risk-wise not all are the same. There are low and high risks. The low risk investment vehicles are like bonds or certificates-of-deposits (CDs). Meanwhile, the high risk investment vehicles are like options or futures.
Let’s see a little bit more about some of the investment vehicles!
1. Stocks
Probably the most commonly mentioned investment term after the pandemic hit. A stock is a form of security that indicates the holder owns a portion of the issuing company. The units for stock are called “shares”.
Usually, corporations sell (issue) stock to raise funds too. So, when you have some shares in a company, you are also entitled to some of its earnings. This also means that owning stock gives you the right to vote in shareholder meetings, receive dividends (which are the company’s profits) if and when they are distributed, and it gives you the right to sell your shares to somebody else.
Typically, stocks have higher risk as compared to bonds.
2. Bonds
Also known as debts. When you buy a bond, you become a lender. So this vehicle is different from stocks as bond lenders don’t own anything as compared to stockholders.
How it works is that you simply lend money to a borrower in return for periodic interest payments (or more commonly known as coupons). Then, at the end of the period (when it reaches maturity), you get your whole original money back.
You can invest in two kinds of bonds usually: government bonds or corporate bonds.
For government bonds, the money lent are usually used for whatever the government usually does like building infrastructure perhaps, etc.
For corporate bonds, these are issued by companies or firms that need funding for projects or whatever initiatives that they are trying to do to grow their companies.
So, since you earn your interest periodically, it is considered a more conservative and safer way of investment as compared to stocks.
However, you don’t just anyhow pick a bond. There is one factor to consider when buying bonds which is creditworthiness. Moody’s, Standard and Poor’s, and Fitch are agencies that usually publish bond ratings to show a borrower’s creditworthiness and this is how you first choose your bond by looking at the grades first.
As long as the borrower is in good financial shape, usually you are pretty much guaranteed the interest payment and the return of your principal. Otherwise, the company risks going bankrupt and that means you are out of luck.
But remember, a bond with high interest rate doesn’t mean it is safe. In fact, a bond with high interest rate means that the company is very risky that it has to compensate with high interest rate so that they can still get the funding. So, the riskier the company, the higher the chance the company defaulting, the higher the interest rates are usually.
For example: Argentina and US comparison for the default history and the interest rate comparison. US bonds are considered quite safe that its rate is not as high as Argentina’s.
Also, when a company defaulted, usually bond holders would likely to get paid first while stock holders would get paid last which means stock holders would also likely get nothing.
3. Funds
A fund means pooled money. In investment, there are index funds or mutual funds. Funds package a bunch of stocks into a nice diversified portfolio.
This is the best way to earn the average market return and benefit from the wealth building upward trend of the stock market without having to analyse individual companies. This is because pretty much the efforts are passed on to the people who manage them.
4. REITs
Under the asset class, we talked about how real estate is really capital intensive. Another alternative of less capital intensive that is related to real estate is REITs (Real Estate Investment Trusts).
REITs are basically like stocks, whereby you can actually trade on the stock market just like any other stocks. So, if you own some shares of a REIT, you are basically owning a part of that real estate. However, real estate is tangible and REIT is intangible. As such, REITs are waaayyyy more affordable.
So, formally speaking, REITs are like companies that have a huge portfolio of properties. They are shares of ownership.
They generally pay really nice dividends. Also, you don’t have to fix stuff or deal with any property management stuff. All you have to do is just buy some shares and wait for the periodic payment of dividends into your pocket. Besides, owning REITs are definitely way more affordable that you can jump right in with just your brokerage account and some money. This is different from having to purchase a property which requires quite a bit of work for the admin matters before you can start earning.
Bottom line, there is a wide variety of investment vehicles that what I am covering now are just some of them. They can help you to get positive returns, but you have to be aware of the risks of the investment vehicles that you choose in the end. After all, if you don’t understand and jump right in, there is a high chance that you might experience the consequences of the risks without any preparations that can result in bad situations.
Choose the investment vehicles that suit your financial situation and goals, so that you can develop a fitting portfolio as well as the investment strategy that you might use.
Conclusion
It might be confusing initially to not know about asset classes and investment vehicles. Once you know, it can make things easier for you to read more.
There are quite a number of asset classes and spreading out your investment in different asset classes can help to spread out the risk, which is also called diversification. As such, you might want to start seeing which investment vehicles that you are interested in to start building your portfolio accordingly and grow your money further. Also, each of them has their own pros and cons. So, remember to always check before you start investing whether it is your cup of tea.
With that, I hope you have learned a bit more about these two topics and if you find this useful and helpful, feel free to share it!
Thank you for reading.
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