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Choosing Your Go-To Asset Classes

October 14, 2020
8 min
Choosing Your Go-To Asset Classes
Beginner
You will learn

    These asset classes, less known than shares and bonds, have different advantages and disadvantages. The question we have to ask ourselves is: do we want to protect our capital, obtain a return? ETFs and mutual funds guarantee a diversified portfolio, thus cushioning the risk. Cryptocurrencies and commodities, on the other hand, exploit the volatility of the supply-demand leverage by offering a higher risk-return percentage.

    ETFs and Index Funds

    The acronym ETF stands for Exchange-Traded Fund.
    ETFs are passively managed investment funds. An ETF takes a reference index, called a benchmark, and copies its performance.

    passive management

    Indexes are bundles of financial instruments representing a certain market (Italian, French, American…) or sector (agricultural, energy, videogames…). An example of a financial index is the FTSE 100, which includes the 100 most capitalised companies listed on the London Stock Exchange. Other popular indices include S&P 500 (USA) or DAX 30 (Germany).

    So by investing in an ETF you are investing in a diversified set of shares of large companies representing a specific market. Because ETFs merely emulate these sets of assets, they offer attractive management fees. They range from 0.2% to 1% per year, with an annual average of 0.5%.

    How do you earn with ETFs?

    ETFs save a lot of time in market research and analysis. Like investment funds, some ETFs perform better than others. Performance varies depending on how they replicate the benchmark. Unlike mutual funds, ETFs can be bought and sold on the stock markets as if they were equities. By reading their prospectus you can usually find out exactly what an ETF contains. Since they are diversified, the risk rate and costs are reduced.

    Mutual Funds

    They are a non-traditional asset class that combines the funds of several investors. These sets of funds are invested as a single asset in different types of financial assets. The invested amount is divided into shares. Two great advantages of funds are their diversification and the fact that they are managed by professionals.

    asset classes

    How do you earn with funds?

    By choosing a fund, we rely on an expert to invest our savings in a diversified set of assets. Unlike ETFs, which are passive forms of investment, your return depends on the performance of the fund. In fact, it is the mutual fund that manages the entire investment process. From market analysis to the choice of companies, to balancing the investment portfolio.

    Derivatives

    This is a complex asset class, as they take different forms and are based on an underlying asset. Depending on the price movement of the underlying asset, the value of the product varies. The underlying asset can be of any nature (commodities, securities, exchange rates, weather conditions, etc.). Derivatives can lead to high returns but have equally high volatility. They are also very difficult to understand and use, so it is best to rely on an expert.

    They are used for three purposes:

    1. reduce the financial risk of a pre-existing portfolio (for hedging purposes);
    2. exposing yourself to high risk for profit (speculative purpose);
    3. achieve a risk-free profit through combined transactions on the derivative and on the underlying asset (arbitrage purpose).

    How do you earn with derivatives?

    There are many derivatives and consequently different ways to profit from them. Let us take the case of an option as an example of a derivative product. If you purchase an option on a car, it means that you are buying the right to purchase it under certain conditions. For example, at €30,000 after six months. If after six months the market sells the same car at €50,000, you will still be able to buy it at the price previously set and you will earn €20,000. If, on the other hand, the market sells it at €15,000, you will buy it from the market and you will not exercise your option.

    Commodities

    The most-traded commodities on the market are gold, silver and oil. However, there are also markets for various other primary sector products. To invest directly in commodities you can buy them on a dedicated trading platform. Alternatively, you can invest in commodity derivatives. Unlike other asset classes, their value does not derive from an interest rate or company growth. Since they are commodities that can be consumed or transformed, their value depends on the levers of supply and demand.

    How do you earn with commodities?

    You can directly purchase coffee bean lots or a coffee bean derivative contract. Depending on the supply and demand of the commodity, its value will change. By buying down and selling up you can realise a return.

    Real Estate

    It is an asset class that brings few advantages:

    • high returns from rents
    • a market independent of that of shares and bonds.

    However, they are a long-term and illiquid type of investment.

    Investing in real estate is not the same as buying a house. This type of asset requires an in-depth study of the real estate sector. In fact, the aim is to buy with a strong discount compared to the market price. In short, it requires a series of specific valuations that are not made when you buy a house for yourself. If you buy for investment, you generally have to do it with the precise aim of earning money in the long term.

    Investing in real estate does not only mean buying flats, which especially in these times are difficult to liquidate. It also means buying stocks of real estate companies through various asset classes. This last type of investment is more advantageous in terms of commissions and the cut of the initial investment.

    How do you earn with real estate?

    Investing in a property does not pay interest rates, but rents that you receive every month. Furthermore, if the value of the property increases over time, you can resell it at a higher price. As for investing in Real Estate on the stock exchange, it works like any stock or ETF but applied to the real estate market.

    Cryptocurrencies

    Cryptocurrencies are a non traditional asset class. They are not recognised as a financial instrument in a certain number of countries. They are characterised by high volatility but at the same time have high potential returns. This is especially relevant in times of economic recession. Excluded from this are those cryptocurrencies whose price is pegged to traditional assets: stablecoins.

    The mechanism behind the sale of cryptocurrencies is very similar to that of fiat currencies. Their value is in fact dictated by the combination of supply and demand and you profit from strategic buying and selling. To understand exactly its mechanics, we will compare it to the Forex. The Forex is the market for legal tender currencies, such as Euro, dollar or yen. Taking advantage of this comparison, we will explain the various analysis and trading techniques.

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