Stocks, bonds, commodities, real estate, mutual funds… If you have capital to spare, the market offers a variety of different types of investments to choose from. However, with so many options out there, it can be difficult to choose the right one for your needs – especially if you are new to investing or want to diversify your portfolio with an asset class you are not too familiar with.
If that sounds like you, this article may help. It explains the main investment types available to private investors so that you can better understand your options and make educated and confident financial decisions.
1. Ownership investments
These are the most profitable and volatile forms of investment. They include any class of assets that you own, such as:
Stocks are also known as equities or shares, and people who own them are called shareholders. When you buy shares on the stock market, you get a stake in a public company and its profits. You make money by reselling stocks at a higher price than you bought them or by receiving dividend payments from companies you invest in. However, not all companies pay dividends – the ones that do are usually large, well-established corporations.
Private equity is ownership of a company that does not trade its stocks on a listed exchange. You get a share in the business, usually by buying shares through a private equity firm – such as IFSA. The risk is greater than with publicly traded stocks, but so is the potential reward, and you have more direct control over the assets. In recent years, this form of investment has surged in popularity. In 2020, global private equity capital reached a record high of $2.9 trillion. Note: private equity can also be considered an alternative asset (see below).
This includes any real estate that you buy to resell or rent out.
Entrepreneurship, or putting capital, time and work into starting and running a business, is also a form of ownership investment.
These include art, collectibles, precious metals, gems and similar items that you buy to resell.
2. Lending investments
Lending investments are debts you buy. If everything goes well, you turn a profit when the lessee repays the loan amount or principal with interest.
Compared to ownership, these types of investments tend to have lower returns but are generally safer. It is often advised that a person keeps some lending investments in their portfolio to balance out higher-risk investments. Examples include:
When you purchase a bond, you loan money to a business or government. They then repay you over a set period with a fixed interest rate. The interest is typically paid in instalments once or twice a year, and the principal is paid on the bond’s maturity date. The main risk with corporate bonds is that the issuer may default. Government bonds are backed by the government and are usually safer. However, less risky bonds tend to have lower interest rates.
Banks and credit unions offer various low-risk instruments such as savings accounts and certificates of deposit (CDs). Note that the interest on most savings accounts is lower than the inflation rate. You can normally get a higher rate with a CD. This is a promissory note a bank issues in exchange for your money. Instead of accessing your cash at any time, you “promise” to keep it locked in the account for a fixed period.
3. Cash equivalents
These investments have high liquidity and are “as good as cash,” meaning you can convert them into cash quickly and easily.
Money market accounts
These are similar to certificates of deposit and can be bought at most banks. The difference is that money market accounts tend to have larger minimum balances and are more liquid, allowing you to withdraw cash without incurring a penalty. On the flip side, money market accounts usually have lower interest rates than CDs.
Treasury bills or T-bills are issued in South Africa by the National Treasury. When you invest in T-bills, you essentially lend money to the government. T-bills do not pay interest. Your profit is the difference between the purchase price and the redemption value. More info about treasury bills in South Africa here.
For most purposes, the different types of investments are usually pigeonholed in the broad categories of ownership, lending and cash equivalents, as outlined above. However, investment companies break down investment types by asset class: bonds, stocks, cash and alternatives.
Alternatives are everything that is not bonds, stocks or cash and may include ownership as well as lending investments. Examples include:
This is capital you invest in a startup or small business. If the venture grows, you get a return on the investment. Venture capitalists often become partners in companies they invest in and have a say in how they are run.
As mentioned at the start of this article, private equity falls under ownership investment. However it can also be considered an alternative asset in so far as it doesn’t form part of the traditional types of investments. Private equity is sometimes confused with venture capital as both involve firms investing in companies. The difference between them lies in the types and sizes of companies invested in, the financial commitment required, and the percentages of equity they claim. In general, venture capitalists invest in technology startups with the potential for high growth. Private equity firms buy SMMEs in any industry and help to streamline their operations. As an example of this, learn how IFSA helped transform Reymar Freight.
If you do your homework and find a private equity firm you know you can trust – because they are directly involved in the management of the company invested in, for example – this form of investment has the potential to offer high returns and less volatility.
Real estate investment trusts (REITs)
REITs are an alternative to conventional real estate investing. Instead of buying properties yourself, you partner with a company that makes its own real estate investments. You can purchase REITs that give you a share in a property or invest in a mortgage as a lending investment.
Commodities are raw materials or primary products such as oil, coffee or copper.
Although cryptocurrency is growing in popularity, it’s still considered high risk. However, there is potential for high return, so this is a good option for those with spare cash looking to diversify their portfolio.
This is a newly emerging alternative asset. Non-fungible tokens (NFTs) refer to items that are one of a kind and cannot be replaced – usually digital. Like cryptocurrencies, NFTs are powered by blockchain technology. Wondering if this trend will gain any traction? Someone recently paid nearly $400,000 for a 50-second Grimes video.
Funds are not a specific asset class but rather collections of different types of investments. They are managed by investment companies that curate groups of assets for you, such as stocks or bonds, in return for a fee. Funds are a convenient way to outsource your investing and often generate better returns than anything you may select on your own.
These funds pool capital from many investors and put them in stocks, bonds and other assets. Mutual funds are run by professional managers with the goal to meet the investment objectives stated in the fund’s prospectus.
Index funds are mutual funds that mirror the return of specific portions of the market or market indices. To do that, index funds own stocks in the same proportions as the target index. Because they mirror the market, index funds are managed passively and have lower fees.
Exchange-traded funds (ETFs)
Like index funds, ETFs track the indices or measures of specific markets. The main difference is that ETF prices change throughout the day, whereas index funds only change price once daily.
Hedge funds are similar to mutual funds but can include a broader range of investment types and often use borrowed capital.
Struggling to Make Sense of the Different Types of Investments?
We can help. At IFSA, we carefully curate low-risk and low-volatility private equity investment opportunities for our clients and personally sit on the boards of directors of the firms we invest in. We do all the research and heavy lifting so that you can have peace of mind.
To start the conversation, book a free one-on-one introduction with our team.
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