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Live Off Dividends

Which Asset Class is Right for You?

Updated: Jan 26, 2023


In the world of so many asset classes, you might be wondering what is the best asset class for me? So we come with this article about 5 top investment options to explain and help you decide.


Asset Classes for investment, stock market, commodities, cryptocurrency, indices, ETF

Asset classes refer to a group of investment vehicles that exhibit the same financial structure and behave the same way in a marketplace. For instance, APPL, TSLA & MSFT are all grouped as equities, as they share the same structure, trade on the same stock exchange & exhibit movements that are positively correlated.


Different asset classes often have low or negative correlations as a result of exhibiting different behavior based on macroeconomic factors. Investible assets include both tangible & intangible instruments, which investors buy and sell to generate money through long or short-term capital appreciation.


Some of the major asset classes include Equities, Commodities, ETFs, Index Funds, and Cryptocurrencies.


Equities


investing in stock market, equities, Tesla, Nvidia, AMD, Apple, Google, Microsoft, MetaPlatforms

Equity is part ownership in a private/public company, which guarantees proceeds in the form of dividends, and at the time of liquidation after all the debts are paid.


The term ‘Equity’ gained popularity in the late Middle Ages, as a result of a system of equity law that was developed in England to meet the growing demand for commercial activity.


While traditional bonds have fixed coupon payments serving as routine cash flow, comparable dividend payments from equities are usually much less certain.


In principle, shareholders are rewarded for owning part of their business in the form of the profits derived by the business after paying for all operational costs.


This is either paid out through the form of dividends or reinvested back into the business, which leads to capital appreciation over the long term.


Shareholders who buy into the company typically receive voting rights, which they can use to influence the direction of the company, either by voting for candidates that they prefer in a board election or by voting on key management policies that can impact the company’s revenues.


Who are Equities For?


  • For those who want Passive Income - Equities have returned close to 3% historically in the form of dividends

  • For those looking at Capital Appreciation - Over the Last Century, Equities have been the best performing asset class, with average long-term returns of 8% per year, making them a lucrative investment opportunity.

  • For those looking to Own Business Decisions - Equities give investors part ownership in the underlying business. Thus, if investors can build a sizeable stake in the business, they can influence the direction taken by the company over the long term.


Who Should Stay Away from Equities?


  • For those Who Don’t Understand the Underlying Business - Novice Investors usually make the mistake of buying stocks for capital appreciation, rather than understanding the fundamentals of the business. In such cases, investors are better of parking money in an index fund & seeing long-term growth.

  • For those Looking to Protect their Investment - While equities have indeed had a solid track record of generating substantial value creation over the years, investing in the wrong stock can be detrimental. Instead, investors can choose to invest in an ETF that comprises a broad range of assets including Equity, Debt, Commodities & Cryptocurrencies, which delivers market returns while lowering risk.


Commodities

Invest in commodities, gas, oil, sugar, gold, coffee, wheat

Commodity markets include raw materials which are used to create final products & include production-grade commodities like Oil, Gas & Gold, and consumable commodities like wheat, sugar & coffee.


Commodity markets have come a long way since the days when farmers had to bring in bushels of wheat & corn into a market.


Things changed in the 1800s when a centralized commodities future exchange was developed to create standardized contracts for agricultural products. Since then, exchanges have been set up around the world, to trade futures & options across a range of commodities including agricultural products, metals & energy products.


As opposed to Equities & Bonds which are Financial Assets, Commodities are real assets that behave differently to external macroeconomic factors. As opposed to stocks and bonds, whose returns erode due to inflation, Commodities are a rare exception, which tends to outperform during high periods of inflation.


As demand rapidly rises during high periods of inflation, the underlying price of a commodity rises as well.


Who are commodities for?


  • For those looking to protect their portfolio against inflation - As commodities are inflation-resistant & in many cases are the primary beneficiary to high-inflation periods in history, they act as a great hedge against inflation in any investor's portfolio.

  • For those looking at diversified returns - Commodities have historically seen a low correlation compared to stocks & bonds, thereby concentration risk and generating positive returns during downturns.

  • For those looking to take risky, high-growth bets - Since commodities typically have an 18-24 month cycle from boom to bust, they can often deliver returns over 300-400% if bought at the right time, making it a very lucrative opportunity.


Who should stay away from commodities?


  • For those who are risk-averse - Commodities are highly speculative instruments & can erode wealth very quickly if the market has already seen a top.

  • For those who prefer predictable returns - Due to its highly cyclical nature, it is far more difficult for investors to predict the returns of commodities compared with other asset classes.


Cryptocurrencies

invest in cryptocurrencies, bitcoin, ethereum, cardano

Cryptocurrencies are digital currencies that act as a medium of exchange traded on decentralized blockchain technology.


Cryptocurrencies are unlike the US Dollar and the Euro as they are not backed by a central authority like a reserve bank, but are broadly distributed through a decentralized network.


While Bitcoin and Ethereum are popular cryptocurrencies, there are over 5,000 tokens that serve as a store of value, utility & payment transfers.


A few years ago, cryptocurrencies seemed like a niche that was limited to just some tech-savvy speculators who were looking to make some money, but in recent years, cryptocurrencies have exploded in popularity and are the world’s fastest growing asset class.


Cryptocurrencies crossed a market cap of $2 trillion in 2021. Such growth and scale suggest that traditional investors can no longer consider Cryptocurrencies as just speculation, as it has risen to prominence as an asset class like no other.


Who are Cryptocurrencies For?


  • For those who prefer an anti-authoritarian system - Since cryptocurrencies run on a decentralized network, they are immune to government interference & manipulation such as devaluation, and also act as a hedge in case of hyperinflation or the potential collapse of a government.

  • For those Looking for a Huge Against Future Risk in their Portfolio - Bitcoin could replace gold in the future as a store of value & act as a hedge against inflation.

  • For those who think that Crypto is the Future - Cryptocurrencies and related technologies are poised to disrupt industries across finance and law, leading to capital appreciation in the future.


Who Should Stay Away from Cryptocurrencies?


  • For those who don’t like Volatility - Cryptocurrencies have seen massive volatility and fluctuations, with prices for tokens varying by 5-10% in a single day and larger drops accounting for 1/5th the price on some days.

  • For the skeptics - Early investors in cryptocurrencies have largely succeeded because they believed in the vision of decentralized technology. Investors who are looking to cash in on the recent boom in cryptocurrencies while not believing/understanding the project should stay away, as a slight downturn can make them sell their entire portfolio.


What are ETFs in investment?


Unlike stocks, where investors buy part of a single business, Exchange Traded Funds enables anyone to hold various underlying assets. An ETF can be structured in a way to track a particular index like the Nasdaq or S&P500, sectors like Automobiles or Technology, Commodities like Steel & Iron Ore, or even specific investment strategies.




As ETFs are traded actively on the exchange, they are comparatively cost-effective & more liquid compared to mutual funds, which trade only once per day after markets close.


Investors can buy ETFs to suit their various needs, whether it may be passive income generation, speculation on macroeconomic scenarios, or hedging against unexpected risk.


For instance, Bond-based ETFs aim to deliver income in regular intervals (income is subject to the performance of underlying bonds), while Commodity ETFs are a great hedge against an economic downturn.


Below is a picture of 5 ETF I selected to show you the different domains which are possible to cover.



Who are ETFs For?


  • For those looking to diversify their investments - Investing in ETFs enables individuals to spread their finances across a range of assets, which results in significantly less risk compared to individual stocks/bonds/commodities

  • For those looking at lower-risk investments - Passively managed ETFs tend to be less risky compared to Mutual Funds & Individual Equities as a result of improved risk mitigation strategies employed.

  • For those who are looking at low fees - ETFs provide affordable access to investors who want to enter the market


Who should stay away from ETFs?


  • Active-Investors - Investors who prefer to trade actively, either on instruments like equities, commodities & crypto, or underlying instruments such as futures & options, are better off not investing in ETFs as they can generate higher returns compared to the market. Investors who can generate excess returns from the market by trading equities, commodities & cryptocurrencies are better off staying away from ETFs.

  • For those who need access to Liquidity - If an ETF is thinly traded, there can be problems getting out of the investment, especially if the size of the investment is large relative to the average trading volume.


Index Funds


An Index Fund is a type of ETF, which tracks the performance of a particular market index, such as the S&P500 or FTSE100.


Index funds provide investors with the opportunity to track the market index, as they cannot directly invest in the index itself. The index itself allocates a certain percentage into each equity, through a weighted average method, based on the market capitalization of the company.


Since Index Funds rely on a passive strategy, they tend to have lower management fees compared to active funds.


For your information, I include below the chart 3 major indexes since year 2000: S&P500, Nasdaq and Dow Jones .



It is represented in a relative form as percentage variation. I can understand if you prefer individual stocks, but the return of the stock market indices is very substantial also.


You can access the indices directly, but also through ETFs, like SPY or QQQ. The major difference is on the trading hours and the minimum imposed investment by your broker. More about that in a different article :)


What could be of much interest, are the leveraged index ETFs, such as SSO or TQQQ.


These ETFs mirror the index funds, but in addition to investor equity, provide a higher level of investment exposure.


In our case, investing 100$ in TQQQ gives you an exposure of 300$ to the Nasdaq100 index. That means you are able to generate 3 times higher returns with your money at the expense of 3 times the volatility.


The best thing about these intrinsically leveraged ETFs is that you do not have to pay the fees which are usually imposed by the brokers when you add the leverage on your own on regular assets:



To illustrate the different return of the 2 assets, am I adding the chart below, which puts them together and shows the relative return:



As you can see, the CAGR of the two is simply incomparable.


 

Hope this was useful for you! Please note that the above content is not an investment advise and shall be considered only for informative purpose.


Feel free to share you comments below.


 

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