The primary lesson that every investor should take the time to understand is asset classes.
Understanding asset classes is important for an investor because when you invest your money in any financial product, it goes to a certain asset class.
The different asset classes are known as cash, equity, fixed income, real estate and alternatives.
Cash is the asset class that everyone is familiar with; it represents liquidity and buying power.
It refers to cash on hand, in bank accounts and money market accounts. This also includes money in your emergency fund.
Equity represents ownership in a business. This refers to individual shares bought on a stock exchange or a collection of shares pooled into equity funds, such as unit trusts, exchange-traded funds or index funds.
When buying equity you are essentially buying a stake into a business or a collection of businesses within a fund.
The various reasons that companies sell their shares are to raise capital to fund research and development, expansion into different markets and new product development to name a few.
Fixed Income represents lending organisation money for a certain period with the promise that you will get all your money back at the end of the term plus a guaranteed fixed interest percentage paid to you over the term.
The most common financial product under the fixed interest category is bonds issued by the government or businesses.
Governments and businesses issue bonds to fund big projects that will require large amounts of money, such as building roads and factories.
Fixed deposit accounts offered by banks work the same way.
A fixed deposit account allows you to put a lump sum in your bank for a fixed term at an agreed rate of interest.
At the end of the term, you receive the amount you initially invested plus the compound interest earned.
To compare equity and fixed income, remember that when buying shares, you are buying ownership into a business in the hopes of your ownership stake growing in value or receiving income through dividend payments.
None of this is guaranteed, and you are not entitled to any of it.
Bonds, however, put you in a position where you are lending money to the government or business, and there is a guarantee at the beginning of the agreement that you will be reimbursed for your initial investment plus a predetermined interest rate for the term.
So, shares represent ownership in a business, while bonds represent money owed to you by the business.
Real estate represents ownership of physical property. This can be a house, flat, plot of land or commercial property, which are all pretty standard.
Another way to invest in property is through a Real Estate Investment Trust (REIT). A REIT offers a hands-off, less expensive and more diversified way of investing in property.
A REIT is a company that develops and manages a collection of income-producing real estate holdings, such as malls, residential development, warehouses, hotels, etc.
As an investor in a REIT, you benefit from receiving a guaranteed income from your REIT holdings, which are distributed throughout the year.
Alternative assets are less traditional investment options. These include commodities (gold, crude oil or wheat), fine art, jewellery and designer handbag collections (Birkin) and livestock.
As an investor, understanding where your money goes is the most important lesson you will learn because these asset classes and their various characteristics also help determine the type of investor you are.
*Thembi is a financial planner and coach. She runs her own financial coaching business FinWellness Solutions. Get in touch at kandangatn@gmail.com