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What Asset Classes Should I Invest In?

By: Elite Legacy Education, November 16, 2016

What Asset Classes Should I Invest In?

In our previous article, What Are My Options for Investing, you learned about the many asset classes out there that you can invest your money in. However, picking the ones that are right for you is a different story. We’re going to point you in the direction of important factors to consider when determining your optimal asset allocation.

 

You’ve seen all of your investing options out there, but what types of assets should you invest in?

Going back to the five main asset classes, here are some benefits offered by each:

  • Money Market: These are good and safe for short-term investments, where liquidity as an investor is required.
  • Fixed Income: Assets in this category are generally safe investments and provide a steady stream of interest earnings.
  • Equity: These investments allow for the opportunity of greater return, but come with an added risk that not everyone can afford to bear.
  • Commodities: Goods in this category are often used to hedge the volatility caused by other assets like equity.
  • Real Estate: A stable asset class that can also be used to reduce the volatility of the overall portfolio.

 

You now know the benefits, but which ones are best for your portfolio?

You will want to consider two major components that will help influence your decision:

  1. Liquidity of personal capital
  2. Level of risk aversion

 

We will discuss each of these factors in detail and how they affect your investing decision.

 

The liquidity of your personal capital.

If you think about it, everyone has some level of pre-determined income that they will earn over the course of their life. Whether you can put an exact value to it is another concern. For now, we will focus on the idea of this concept.

Specifically, we are referring to how when people are younger, most of an individual’s overall capital is tied up in the illiquid state of intellectual capital. You have yet to be paid the years of salary that your knowledge and skills (i.e., education) will eventually earn you. If you look at it this way, you may want to consider investing in assets that provide a steady cash flow when you are younger to help liquidate some of this locked up capital. This is also true in your elderly years since you will have unlocked most, if not all of your potential capital. Cash generating assets would also be appropriate in this context. Thus, if most of your capital is tied up or already liquidated, then you will want to focus more on liquid assets that provide some cash flow for you. If you are in your middle aged years and are currently being paid a salary, then you may not be as concerned with the liquidity of assets.

 

Your level of risk aversion.

You should also keep in mind the level of risk you are willing to take on. Typically, fixed income investments are relatively safer than equity. Of course, with less risk comes less return on a security by security basis. You can reduce your overall risk portfolio by balancing it between equity and fixed income investments.

Your level of risk aversion combines a couple of main factors. These being your age and your investable cash relative to your overall wealth. Of course, the more cash that you are putting on the line in comparison to your overall wealth, the more risk averse you will be compared to smaller amounts.

As for age, it typically goes that the younger you are, the less risk averse you are. This is based on the premise that as you grow older you have less time to make that money back. This is especially true as you near retirement since you do not want to risk losing your resources meant to sustain you through these years.

Thus, the less risk averse you are, the more you may want to lean towards equity since bearing more risk generally leads to larger returns. Of course, this doesn’t apply to deals that do not provide a competitive risk adjusted return (i.e., huge risk for mediocre payoff). On the other hand, if you are more risk averse then you may want to lean towards a portfolio with more fixed income investments.

Ultimately, you should use all of these considerations as guidelines for determining how to allocate your personal investment portfolio among the different asset classes.

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