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Asset Classes Explained (ULTIMATE BEGINNERS GUIDE: CASH, STOCKS, BONDS, REAL ESTATE & COMMODITIES) - YouTube
Channel: fu academy
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Hey guys and welcome back to fu academy!聽
In today's video, we will take a look at聽聽
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the different asset classes. We will cover聽
the basics and really go into the detail聽聽
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and look at the pros and cons of each聽
asset class. So, let's get right into it.
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You have decided to invest your money -聽
great! Now you're looking at something聽聽
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to invest in. The only problem: The world of聽
finance has hundreds of financial products聽聽
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which makes investing for private investors like聽
you and me confusing. However, if you understand聽聽
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which asset class each financial product belongs聽
to, then this whole investing thing becomes聽聽
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so much more simple! When talking聽
about stocks, bonds or buying a house,聽聽
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we are also talking about asset classes. An聽
asset class is a broad group of investments聽聽
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that share similarities, such as how they聽
behave in the market, the buying process聽聽
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and how they are regulated. Each asset class聽
has its own unique risk and return profile.聽聽
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Those risks and returns are constantly being聽
impacted by economic, political and social events.聽聽
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There is no standard list of asset classes, but it聽
is widely accepted that there are 6 type of asset聽聽
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classes out there. This is cash, equity, fixed聽
income, real estate, commodities and alternatives.聽聽
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Alternatives is an asset class that includes聽
artwork, stamps and other tradable collectibles.聽聽
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Some people also include cryptocurrencies聽
as an example for alternative investments.聽聽
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I won't go into detail into this specific asset聽
class since there is so much content here that I聽聽
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could make a video on its own. Okay, let's have聽
a closer look at each of these asset classes.聽聽
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All right let's start with the first one: Cash.聽
Cash is king - everyone knows this phrase. This聽聽
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could not be more true from an asset class聽
perspective. Cash includes idle money such as聽聽
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the one in your bank account, savings account,聽
in your pocket or hidden under your pillow.聽聽
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In general, cash gives you the freedom to buy聽
anything instantly since it's regarded as liquid.聽聽
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No other asset class gives you more freedom than聽
cash. You can use it straight away. A house,聽聽
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for example, would be the opposite of this: Very聽
very illiquid. A house cannot instantly be sold or聽聽
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exchanged for cash. Everyone is advised to have聽
an emergency budget which can cover your living聽聽
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expenses for 3 to 6 months - just in case you lose聽
your job or you get hit with an unexpected bill.聽聽
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Let's look at the pros and cons of this asset聽
class. Pros: This asset class is considered to聽聽
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have the lowest risk. Apart from the slow and聽
steady devaluation of cash due to inflation,聽聽
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you won't lose your money instantly - unless聽
your local currency or your entire monetary聽聽
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system collapses. Don't get me wrong: These聽
events have happened in the past. But they can聽聽
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be considered an extraordinary event that won't聽
happen very often. Okay, let's look at the cons:聽聽
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Due to inflation, the value of your cash will聽
constantly and gradually decrease in value.聽聽
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So, this asset class cannot be聽
considered a long-term investment聽聽
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that you can build wealth with. It's聽
just a tool that gets you to invest.聽聽
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Now, let's move on to equities. This is the most聽
volatile asset class. But when treated right,聽聽
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it can get you the highest returns. If a聽
company is publicly traded, so listed on聽聽
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the stock exchange, you can invest money in those聽
companies directly via a broker and buy ownership聽聽
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in a specific company. This ownership comes with聽
some really nice benefits. In an ideal scenario,聽聽
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the company you invested in makes profits.聽
That ownership in the company that you bought聽聽
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now gives you the right as a shareholder to聽
participate in those profits if the company聽聽
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decides to pay dividends. Dividends are one way聽
how you make money on stocks as an investor.聽聽
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But there is another way: Capital gains. Capital聽
gains is the increase in value of a capital asset,聽聽
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for example a share in a company. Let's say you聽
buy one share of a company for 1,500 dollars.聽聽
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One year later, the share price of that company聽
rose to 2,000 dollars. If you then decide to聽聽
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sell this stock, you will get back 2,000 dollars.聽
And in this process, you generated 500 dollars in聽聽
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capital gains. Now, let's imagine that the company聽
doesn't do too well and it needs to be liquidated.聽聽
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So, it files for bankruptcy. Even in this very聽
dark scenario, your ownership in a company would聽聽
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guarantee you a portion of the money that is left聽
over after the company paid off all its debt.聽聽
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Individual stocks of certain companies are just聽
one form how to invest in equity. You can also聽聽
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buy an entire basket of companies at once that聽
include hundreds and thousands of companies.聽聽
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This is called Equity ETF, which stands for聽
exchange-traded fund. Here, you don't put all聽聽
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of your eggs in one basket, but instead diversify聽
your investments across sectors and countries.聽聽
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What are the pros? Well, this asset class -聽
for a long-term investor - offers the highest聽聽
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returns compared to all the others. The average聽
annual return since the inception of the S&P 500聽聽
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was 8%. And you would have gotten this without聽
even knowing anything about financial analysis聽聽
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of companies. You would have gotten聽
these results by simply buying an聽聽
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ETF that tracks a basket of companies.聽
Another advantage of equities are dividends.聽聽
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You essentially get paid on a regular basis聽
without doing anything. And in a normal case, the聽聽
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value of your stock will increase simultaneously.聽
Okay, let's look at some of the cons - and there聽聽
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is a big one! Equity markets can crash -聽
like really bad! On the 19th of October 1987,聽聽
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also known as Black Monday, the S&P 500聽
declined by more than 20% - not in a month,聽聽
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not in a week. In a single day! In order to聽
succeed as an equity investor, you really need聽聽
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to take your emotions out and you need patience.聽
If you don't bring with you a time horizon of at聽聽
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least 10 years, there is no guarantee that聽
you will make money in this asset class.聽聽
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Even if your time horizon is more than 10 years,聽
there is still no guarantee that you won't lose聽聽
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money in this asset class. Please remember:聽
There is no such thing as risk-free investment.聽聽
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If you do stock picking, which means individually聽
selecting companies that you want to invest in,聽聽
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it is important to make sure that you do your聽
proper due diligence before investing. This will聽聽
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be very time consuming though and requires聽
a lot of solid financial understanding.聽聽
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Right, next asset class: Fixed income. Fixed聽
income, as the name says, refers to a type聽聽
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of investment that pays the investor a fixed聽
interest or dividend payment until a certain聽聽
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maturity date. The payments of these fixed income聽
streams are known in advance to the investor.聽聽
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At maturity, the investor is repaid the聽
principal amount they originally invested.聽聽
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Essentially, these are IOUs, where a borrowing聽
party lends money with the promise to pay back聽聽
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the loan at the end with regular interest payments聽
along the way. The most common types of fixed聽聽
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income products are government and corporate聽
bonds. When issued by a government or company,聽聽
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the bonds can be bought and sold openly聽
in the markets. Let's check out the pros.聽聽
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Well, there is no such thing as a risk-free asset聽
class. But fixed income assets are considered to聽聽
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be lower risk investments. After all, the聽
investor receives a fixed rate of interest.聽聽
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And the borrower also promises to pay聽
back the investor at the end. Therefore,聽聽
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this asset class is very attractive for people聽
who are looking to retire soon as it provides聽聽
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a steady stream of income during retirement. What聽
are the cons? Well, sure: This asset class offers聽聽
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a higher safety for investors. But its upside聽
in terms of gains is also very limited.聽聽
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Historically, fixed income assets have performed聽
stable at times when other asset classes crashed.聽聽
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But at the same time, well, performed stable聽
when other asset classes have skyrocketed.聽聽
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Now, let's move on to real estate. Real estate聽
is one of the oldest and most popular asset聽聽
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classes. This asset class includes physical聽
assets such as land, residential houses,聽聽
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apartments, commercial buildings, industrial聽
and retail areas. Real estate also includes聽聽
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tradable assets in the form of REITs, which聽
stands for Real Estate Investment Trust.聽聽
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Essentially, REITs are investment firms that own聽
and manage a portfolio of real estate properties聽聽
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and the underlying mortgage. Anyone can聽
buy shares in a publicly traded REIT.聽聽
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They offer an easy exposure聽
to the real estate sector聽聽
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without having to put down a deposit for a聽
mortgage or the struggles of being a landlord.聽聽
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The idea of buying real estate is very聽
appealing to many of us private investors聽聽
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because it is simple to comprehend. At the聽
end of the day, a house is something tangible.聽聽
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You can see it you, can touch it. It is聽
not as abstract as the other asset classes.聽聽
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But does it also mean that it is a better class聽
to invest in? Well, let's look at the pros: When聽聽
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chosen wisely, real estate has a relatively high聽
likelihood of appreciating in value over time.聽聽
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On top of the capital appreciation, you聽
also get a steady rental income stream聽聽
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if you decide to rent out your property. Whilst聽
individual stocks of companies can go bust and聽聽
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lose 100 of their value, a property should always聽
have an underlying value left and should never be聽聽
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completely worthless - unless it's wiped out聽
due to a natural disaster, of course. Also, as聽聽
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a private investor, you get the chance to actively聽
impact the value of your asset by renovating it or聽聽
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doing house flipping. In short, house flipping聽
would be buying a property that is not in a聽聽
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good shape but has the potential to increase in聽
value over time with some tweaks here and there.聽聽
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After completing the work, you make money from聽
selling the property for a much higher price. Now,聽聽
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let's look at some of the cons: In order to聽
buy physical real estate as a private investor,聽聽
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you need to put down a聽
significant amount as a deposit聽聽
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and need to have a good credit history聽
in order to qualify for a mortgage. Also,聽聽
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there are many additional charges when buying a聽
property such as brokerage fees, stamp duties,聽聽
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notary costs and so on. Furthermore, methods like聽
house flipping can be super super time-consuming聽聽
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and don't necessarily have to result in a profit聽
when deducting all material and labor costs.聽聽
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And yes, although you can actively impact聽
the value of your asset with renovation,聽聽
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the main part of the value change is driven聽
by external factors that you cannot impact.聽聽
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Also, if you plan to rent your property out,聽
it can be time-consuming to find a tenant,聽聽
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deal with that tenant in collecting the rent聽
money or continuous repair works around the house.聽聽
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And lastly, real estate is not a liquid asset and聽
therefore you will not be able to turn it into聽聽
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cash easily in case of an emergency. Okay, let's聽
move on to the last asset class: Commodities.聽聽
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Commodities are tradable items that are聽
components in the production of other goods,聽聽
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and therefore part of the supply chain. The聽
most representative examples of commodities are聽聽
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precious metals such as gold and silver,聽
raw materials such as oil and gas聽聽
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and food products such as wheat, sugar, coffee,聽
beans and potatoes. Each commodity has its own聽聽
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market and dynamics and is usually super聽
price sensitive to economic market cycles聽聽
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as well as supply and demand. They can be products聽
that can spoil easily such as food products,聽聽
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but they can also be products that last for a聽
long time such as gold. Let's look at the pros:聽聽
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Trecious metals like gold and silver can be聽
held by investors for a long time because they聽聽
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can be stored without losing their value.聽
Although the price of precious metals can聽聽
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fluctuate heavily in the short-term,聽
the underlying value of them will remain聽聽
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relatively stable and resistant to inflation聽
for thousands of years. To illustrate this,聽聽
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people often use the example of the toga-to-suit聽
ratio. So, in Ancient Rome, 1 ounce of gold聽聽
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could buy you one tailor-made toga. Today, 1聽
ounce of gold is worth roughly 1,900 dollars.聽聽
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This will also buy you a pretty nice tailor-made聽
suit. So, it shows that gold has held its聽聽
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underlying value despite 2,000 years of inflation.聽
But there are also, of course, some cons:聽聽
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Commodities are meant for trading and not for聽
long-term investments - unless it's a precious聽聽
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metal. For private investors like you and me, it聽
is usually impossible to store a huge amount of聽聽
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physical food crops in your home as a long-term聽
investment. As an asset class, commodities are聽聽
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considered a more specialised area of investments聽
that can perform at times when more traditional聽聽
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asset classes don't, making them an interesting聽
diversification option - not more, not less.聽聽
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Great, so we looked at different asset classes and聽
investigated their pros and cons. Just to recap:聽聽
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Today we looked at 5 asset classes. Number聽
1: Cash. It's a low risk asset but gradually聽聽
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decreases in value over time due to inflation.聽
Cash is just a tool to get you to invest.聽聽
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Number 2: Equity. This is the asset class with the聽
highest returns compared to all the others. But聽聽
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it's also volatile and risky. So make sure you聽
have a long time horizon when investing in it.聽聽
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Number 3: Fixed income. It is considered聽
to be a lower-risk investment.聽聽
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But it's upside in terms of gains is聽
very limited as its returns are fixed.聽聽
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Number 4: Real estate. It can appreciate in value聽
whilst giving you the option of generating regular聽聽
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income streams by a rental income. But it can be聽
capital intensive to get started with and it can聽聽
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be time-intensive in terms of maintenance. And on聽
top of that, it's a very illiquid asset. Number 5:聽聽
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Commodities. Precious metals like gold and silver聽
don't lose their value over time, whilst more聽聽
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traditional commodities such as raw materials聽
or food products are the opposite of this.聽聽
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As discovered above, each asset class has its聽
advantages and disadvantages. If only there could聽聽
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be a way how we could combine all of the assets聽
and make use of all of their advantages whilst聽聽
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balancing off their disadvantages. Oh, wait!聽
There is a way! It's called diversification of聽聽
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asset classes. One example of a diversified聽
portfolio would be Ray Dalio's All-Weather聽聽
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Portfolio. I actually made a video about it and聽
explained the concept, the asset allocation,聽聽
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the historical performance, pros, cons聽
and how to construct it yourself. So聽聽
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please make sure you check that video out.聽
I will link it in the top right corner. So,聽聽
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I hope this video could help you to get a better聽
understanding of how the different asset classes聽聽
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work. I hope you now have a basic understanding聽
of the pros and cons of each asset class.聽聽
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Leave a LIKE on the video if you did enjoy the聽
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SUBSCRIBE to this channel. I'm just getting聽
started and it's the easiest and most helpful way聽聽
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