Trading and investing
Each investor has their own goals, and the distribution of assets in their portfolio will reflect this.
The examples below are quite informative and show how different types of investors choose assets to invest in.
Example 1: A Cautious investor
A thirty-year-old girl is saving for retirement, and you can expect her to invest mostly in equity funds. But she treats the stock market cautiously, has no experience in investing, and has experienced several downturns. She feels more confident investing 20% of her capital in stocks and 80% in bonds.
Example 2: A couple where both spouses work.
Married and working forty-year-old spouses want to create additional capital for retirement in 20 years. A portfolio consisting of 70% stocks and 30% bonds will suit them. However, the spouse’s job, which provides about half of their income, has become unstable, and they are worried about their financial future. So they choose a more conservative allocation, and invest 50% in stocks, 40% in bonds, and 10% in money market instruments.
Example 3: A recently retired couple.
A recently retired couple initially wanted to invest 30% of their capital in stocks and 70% in bonds. However, the projected future revenues were less than necessary. They also want to build a bigger home for their grandchildren. So they opted for a more aggressive asset allocation, consisting equally of stocks and bonds. In this example, they expect to get a higher long-term return by taking on additional risk.
Asset classes over time
Investment markets have cycles that reflect the underlying economy, industrial trends, and investor sentiment.
The table shows the annual income from major asset classes over the past 20 years. The color indicates the assets that showed the maximum income in a particular year.
It’s easy to see that different classes behaved very differently, which reminds you of the importance of diversifying your portfolio. The basic principle is very simple: a combination of assets that do not tend to rise or fall at the same time (i.e., have a low correlation) can potentially reduce your overall risk.
Investment management methods
There are several ways to invest in the various asset classes described above, but one of the easiest ways is to use the services of a professional asset management company. The basic concepts are described below.
Use of investment funds
Investment funds provide an opportunity to create a diversified portfolio.
The fund works as follows: investors transfer their funds to it, and the manager then invests them in a set of securities. Each investor is assigned a share in the financial result of the fund, including any cash flows from the securities included in it.
Each fund is managed by a manager who operates according to the fund’s investment declaration and invests investors ‘ funds in stocks, bonds, real estate, money market instruments, or a combination of these assets.
Potential benefits of investment funds
– Diversification
One fund can invest in several stocks or even several hundred shares. This diversification can reduce the risk of losses due to problems in a particular company or industry.
– Professional management
Fund managers have access to extensive analytical materials, market information, and are assisted by qualified traders.
– Liquidity
Shares in the fund can be bought or sold during any business day, so investors have relatively easy access to their money. Units of ETFs and Investment Trusts have an additional advantage – they are traded on the stock exchange during the day.
Potential disadvantages of investment funds
– The downside of diversification
While diversification reduces the risk of owning a single stock that is falling in price, it also limits the potential for extraordinary returns. And, most importantly, diversification does not protect against losses caused by a general decline in financial markets.
– A common set of promotions for everyone
Mutual funds are not custom portfolios. As a result, they correspond exactly to the manager’s vision, but do not always coincide with the investor’s vision.
– Lack of guarantees
As with many other investments, the value of the fund’s share will fluctuate, so there is a chance of incurring losses if you sell the share for less money than what it was bought for.
It is important to remember that the value of investments and the cash flow from them can decrease or increase, and investors can get back less than they invested.
Different types of investment funds
Unit trust.
A fund created by the management company. The fund is open – ended, which means that the management company can issue or redeem shares depending on the requests of investors.
In a broad sense, investment funds can be actively or passively managed.
1. Active managers aim to exceed, rather than just match, the return on an index or benchmark. To do this, they can use several methods. There are usually two approaches: top-down and bottom-up.
Top-down: In this case, managers start by analyzing economic trends in order to predict which sectors of the economy will thrive in the future. After determining the list of industries, they look for the most promising companies in each industry.
Bottom-up: These managers are looking for outstanding companies in any industry. They assume that a strong company will perform well, even if it doesn’t belong to a successful industry.
2. Passive or index managers try to match exactly the returns of the index or benchmark. They do this by buying all the stocks that make up the index, or a set of stocks that follows the performance of the index.
Index – tracking fund
An investment fund that aims to replicate the dynamics of a particular market index.