Financial investment: types of instruments (+ the EASY one)
You’re probably wondering what are the main investment methods for a common person with a modest (or very limited) budget, and if there’s something simple to start with, maybe in a short time.
The financial world is constantly changing, and together with the classical and so to say historical methods, there are now new innovative ones.
It’s important to know all of them because one of the first rule of a good investment is to diversify risk by investing in different types of assets, what in technical jargon is knows ad diversifing the investment portfolio.
In this lesson of the course we will explain in very simple terms the main financial investment methods of today and their main features, including also the one with which you may start with very little capital and in a very short time.
Classic investment instruments
– SHARES as an investment instrument
From Investopedia: “A share is a unit of ownership interest in a corporation or financial asset”.
Owning one or more shares of a company literally means to be a member of that organization, then to have the right to vote, but, above all, the right to earn from the profit produced by that company, usually in proportion to the number of shares held.
So, if you own the 1% of a company’s shares, when and if it will decide to distribute the so-called dividends, you will cash out the 1%.
However, the peculiarities might be many, and not all companies pay the dividends to its shareholders. In that case, the shareholder will be able to make money from his investment gaining from the growth in value of its shares, and the subsequent sale to another investor.
A company’s shares are subject to the fundamental market laws of supply and demand, so, in general, the more a society is strong, the more its shares will be required and therefore the more their value will go up. Conversely, the more a company is weak, the more its shares will be unattractive, people will not want them and they will lose value.
This means that if shares pays no dividends, you can only gain from the fact that they increase in value, which in other words means to speculate on the difference between the sale and the purchase price.
The percentages of return on the investment can be very high, but on the other hand, there are also many risks that the share’s value simply doesn’t rise up in value, or even that it goes down.
– BONDS as an investment instrument
From Investopedia “A bond is a debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.“
Having a bond means having lent money to another company, and having in your hand a title that certifies that the company has a debt towards you, which must be compensated on a specific date, together with the payment of pre-determined interest, to honor your loan.
Usually the more risky the company to which you have lent money is, the higher the interest will be. Conversely, if the company is considered less risky your investment will be paid at a lower interest rate. Or, if the company knows to be less attractive than others, to attract customers it can put into circulation bonds that pay a higher interest.
The most famous bonds are the governments bonds, like the USA Bond, the German Bund, or the Italian Bot.
The fact that they are called bonds (obligation) is to indicate that those who receive the money borrowed are obliged to repay the capital, plus the interest on the indicated date. So, we have a fixed date and a fixed return.
From one point of view we can say that bonds are risk-free investment, although they are not. The companies can still fail and therefore no longer fulfill their debts, and never as in recent years we have had firsthand experience of the fact that states themselves may go bankrupt (see Argentina).
Aside from the risk of failure, which, however, considering states, remains small, the relative safety of this instrument obviously has a price, and it’s the fact that bonds produce very small percentage of return, sometimes really tiny.
Shares on the other hand can offer much higher yields, but there is obviously a risk that these returns do not come at all.
– MUTUAL FUND as an investment instrument
From Investopedia “A mutual fund is an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors“.
In other words, when you invest in a fund you become part of a group of people who have collected together their money, which it’s then delivered to a expert investor to handle it.
The manager then go with that capital to buy stocks and bonds and build up the mutual fund. The profits are then distributed in relation to the shareholding stake in that fund.
There are hundreds types of funds. Funds that invest in baskets of securities, funds that tend to replicate an index or set of indices, funds managed passively or actively, including the well-known hedge funds. The distinctions that can be done are many.
Usually many of these investment funds are hooked on savings plans or insurance policies, and are used by users who are not willing to spend time learning how to invest independently.
The benefits are many in that sense, as well as the disadvantages. The main disadvantages are that the returns on the investment are often very poor, affected in many cases by the high operating costs. The operator must be paid in any case, even if he fails to produce any profits, and the risk of a “creative” management, which aims at generating commissions rather than generating profits are just around the corner.
In many respects, these tools are used by those who have large investment capacity and uses them to keep their capital away from inflation and gain something if things go well.
In simple terms, inflation means the rising of prices of goods and services, resulting in a reduced purchasing power. If today, with your funds, you can buy a certain number of goods and services, it doesn’t mean that in a few years, with the same money, you can buy the same amount, because the price of those goods and services will be increased, due to inflation. It’s also called a decrease in purchasing power.
Those who invest in these types of instruments usually look first and foremost at preserving the purchasing power of their capital, and then, if it’s possible, to earn something.
Speculative investment instruments
The first 3 investment categories include, in a sense, the actual purchase of an asset, whether it’s a stock, a fund stake or a share, to be kept and preserved, waiting for them to generate returns through appreciation or dividends.
The tools that we will see now do not involve the actual purchase of the good, and it’s not necessarily assumed that the good has to appreciate to generate a profit. Here we enter in the speculation and short selling territory, where you can earn even after the depreciation of a particular asset.
Usually the world refers to these tools as “derivatives“, because their price derives from the market value of another financial instrument, defined underlying (such as, for example, equities, financial indices, currencies, interest rates).
Despite many times we hear certain terms such as “speculation” or “short selling”, and most of the times not with positive connotations, I invite you to investigate the issue, to understand how the tool itself is not the problem, but only to use that just a few individuals make.
– OPTIONS as an investment instrument
From Investopedia “An option contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).
In other words, with an option agreement I have the right (not the obligation) to buy or sell an asset at a specified price and / or within a certain date, paying immediately a small fee to get this right.
In case there will be favorable conditions, I will confirm the purchase or sale option as written, making my investment bear its fruit; if instead the conditions will be unfavorable, I will not conclude the transaction, and I will avoid the loss, but I will of course NOT recover the initial cost already paid.
Within this basic operations there are a long series of advanced strategy, such as the opportunity of selling these contracts instead of buying them, but this is not the place to talk of this topics.
– FUTURES as an investment instrument
From Investopedia “A future is a financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price.“
In practice, with futures you get the right to buy or sell goods at a price and date that have been established at the moment of creation of the contract.
Upon expiration of the futures contract, the investor will benefit and gain from the difference between the purchase or sale price established with the future, and the current market price of the underlying asset of the future itself.
Obviously, if this difference is positive, there will be a gain, conversely a loss.
The future underlying assets can be both real, such as commodities (wheat, gold, metals, coffee, etc) as well as financial. In the latter case, we will talk about “financial future”, whose underlying assets can be, for example, a currency (currency futures) or a stock market index.
– FOREX as an investment instrument
The Foreing Exchange Market, commonly called Forex or Fx, is the currency market, the largest market in the world and the most well known in our times. Forex is not an investment, but a market where instruments such as options or futures, in addition to the mere purchase and sale (the spot market), can be used.
In this market participant don’t exchange goods, but only currency pairs. In fact, a currency is never bought or sold individually, but is traded on the basis of the equivalent with another currency through an exchange. Speculators invest on the fact that this exchange between the two currencies will grow or diminish.
Options, Futures and the Forex market offers huge earning potential, but obviously, given the law of compensation, the risks grow hand in hand. In addition to this, the level of knowledge and experience necessary to be able to invest profitably in these areas is very considerable (check out our list of the best forex trading sites for beginners).
Compared to rely on others to buy stocks, or bonds, or mutual fund shares (which does not require time to be learnt), to act personally in these areas for sure takes years of deep and intense studies.
Any promise of being profitable with little or no effort should at least keeps your ears peeled, because statistics show that around 90% of those who try these difficult instrument by their own, without the necessary studies, miserably fail.
– SOCIAL TRADING as an investment instrument
Its key feature is the fact that it stays halfway between the two main categories seen so far:
- on one hand the simple acquisition of shares, bonds or fund and the passive waiting for revenues
- on the other hand the retail speculation, with a higher risk index, on the forex or stock market, with futures and options or spot.
In Social Trading the investor is the direct manager of his money, he doesn’t rely on any external manager, but at the same time he does not have to buy or sell personally. Thanks to specialized platforms, the investor can view a portfolio of market operators, called traders (or Signal Providers), he can observe and compare their styles and performances, and, if interested, he can choose to connect his account to one or more of these traders.
Once connected, all the operations made by the trader on his own account, will be replicated automatically on the investor’s account via the Social Trading platform. So, it’s not the investor deciding what kind of operations to do, but it will be the trader he had chosen in the initial phase.
Once the favorite traders have been chosen, the investor can leave his money to work and periodically perform control operations on his investment.
Earnings, compared to the amount of capital used, can be definitely higher than those of bonds and even stocks, and also the timing might be shorter. On the other hand, there is still risk, but with the proper knowledge it will certainly be much lower than the retail Forex speculation, since the investor relies on traders who have already proven to be profitable.
We will see in detail the potential of this new form of investment in the dedicated course. But for now, do not rush, and first terminates this course, because here you will find the most important concepts for the success in any investment, including, of course, with Social Trading.