Different investments can be grouped into different categories, called Asset Classes. The asset class is a group of investments that show similar characteristics. There are four broad asset categories or asset classes, and then there are different sub-categories within each of these. Four comprehensive categories - real estate, items, equity, and fixed income.
Real Estate 🏠
The most significant and well-liked asset class among all others is real estate. Nonetheless, this asset class has a high level of appeal for reasons unrelated to investing. The biggest cost in a person's life is their home, according to those who have purchased one. The term employed in this context is cost, not investment. This will be explained in more detail later, but for now it is important to note that most people buy real estate for their own use. As selling it can negatively affect one's lifestyle, it shouldn't be viewed as an investment.
Residential real estate, land, commercial real estate, etc. are some further categories into which real estate can be divided.
As an asset category, real estate exhibits certain traits, some of which are listed as under:
Location is the most important factor impacting the performance of an investment in real estate
Real estate is illiquid
It is not a divisible asset
One can invest in physical real estate, as well as in the financial form
Apart from capital appreciation, it can also generate current income in the form of rents.
In case of real estate, the transaction costs, e.g., brokerage charges, registration charges, etc. are quite high. This would bring down the return on investment.
The cost of maintenance of the property, as well as any taxes payable must be adjusted before calculating the return on investment, something that many individual investors do not. These expenses are also quite high, and cannot be ignored.
The investments acquired or sold shall be accounted at transaction price excluding all transaction costs such as brokerage, stamp charges and any charge customarily included in the broker’s contract note that are attributable to acquisition/sale of investments.
Commodities 🛢️
This is another asset category that people at large are familiar with in various ways. On a regular basis, people consume many commodities, e.g., agricultural commodities like spices; petroleum products such as petrol and diesel; or metals like gold and silver. However, it is not possible to invest in most of these, as many of these are either perishable and hence cannot be stored for long, or storage of the same could take a lot of space, creating a different kind
of difficulties.
Though there are commodities derivatives available on many commodities, it may not be wise to call these “investments” for two reasons,
(1) these are leveraged contracts, i.e., one can take large exposure with a small of money making it highly risky and
(2) these are normally short-term contracts, whereas the investors’ needs may be for longer periods.
On the other hand, there are at least two commodities that many investors are quite familiar with as investment avenues, viz., gold, and silver.
When someone invests in these commodities, the prices are almost in sync across the world. It is easy to understand the prices of gold and silver across countries by simply looking at the foreign exchange rate between the two countries’ currencies, and making adjustments for various costs and restrictions imposed by any of the countries. In this manner, these two are globally accepted assets.
Both these commodities have been used as investments or storage of value for long. In fact, the history of currency would be incomplete without mention of these two. Gold has also been considered by many as a safe haven asset. In case of failure of an economy, or a currency, gold is considered to be the final shelter. However, the opposite camp also comes with very strong arguments. Many currencies across the world were pegged to the gold reserves available with the central bank of the country for a long. However, this so-called gold standard has been done away with a few decades ago. And still, most of the central banks hold gold in their reserves.
An investor in these commodities would have to count only on capital appreciation since these do not generate any current income.
Gold and silver come in varying degrees of purity. Each one can be bought at different prices from the market. However, for a large majority of investors, it is almost impossible to make out the level of purity. If we opt for a purity certificate, the cost goes up and without one, the risk of getting lower quality metal is high.
Fixed Income 💵
When a person borrows money, the person has to pay back the borrowed principal to the lender in the future. There may also be interest payable on the borrowed amount. There are different forms of borrowing, some of which are through marketable instruments like bonds and debentures.
There are many issuers of such papers, eg, companies, Central Government, State Governments, Municipal Corporations, Banks, Financial Institutions, Public Sector Undertakings etc.
Many bonds pay interest regularly; Hence, investors can expect current income. At the same time, if one has invested in the bond at the time of issuance and holds it till maturity, in almost all cases, there will be no capital gain. On the other hand, transactions through the secondary market—whether buying or selling, or both—can result in capital gains or losses.
Bonds are generally regarded as safer than equities. However, these are not completely free from risks. These risks are discussed in detail in later chapters.
Bonds can be classified into sub-categories based on the type of issuer, i.e., issued by a government or corporate, or based on the maturity date: short-term bonds (ideal for liquidity needs), medium-term bonds and long-term bonds (income generation needs).
Equity 📈
This is the owner’s capital in a business. Someone who buys shares in a company becomes a part-owner in the business. In that sense, this is risk capital, since the owner’s earnings from the business are linked to the fortunes, and hence the risks, of the business. When one buys the shares of a company through the secondary market, the share price could be high or low in comparison to the fair price.
Historically, equity investing has generated returns in excess of inflation, which means the purchasing power of one’s money has increased over the years. It has also delivered higher returns than other investment avenues, most of the time, if one considers long investment periods.
Apart from long term capital appreciation, equity share owners may also receive dividends from the company. Such dividends are shared out of the profit that the company has generated from its business operations. If the company does really well, the dividends tend to grow over the years.
To sum up, equity share prices generally fluctuate a lot, often without regard to the business fundamentals. However, over long periods of time, the share prices follow the fortunes of the firm. If the profits of the company continue to grow over the years, the share price follows.
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