Investment Risk Ladder: A Handy Tool for Beginner Investors

For beginner investors, the thought of putting your hard-earned money in the hands of unknown parties might be intimidating. After all, nobody in their right mind wants to lose money when expecting a gain.

Thus, it is vital for beginner investors to know the fundamentals of investing. Not only will it keep them safe, but it can also benefit them. For starters, we can start learning about investment types and the respective risks of each investment type.

The Investment Risk Ladder

A handy tool for beginner investors, The Investment Risk Ladder ranks asset classes according to their risks.

Cash

Source: Pixabay

The easiest and safest way to invest is by simply putting your money in a bank account. 

Easy, because it’s doable by virtually anyone who can open a bank account. Safe, because of its liquidity (it guarantees that we will get the money back whenever we want). We can also track & plan the amount of money we get from our investment based on the interest rate. 

However, the interest rate is often less than the inflation rate, meaning we might lose money over time when we simply store our cash in a savings bank account. One way to overcome this problem is by Certificate of Deposit (CD), where we agree to ‘deposit’ the money for a while. This is less liquid compared to a savings account since you can get a penalty if you decide to withdraw early.

Bonds

Source: Society of Irish Revolutionary History and Militaria

Upon purchasing a bond, we are basically loaning the money to the issuer. Bonds are typically issued by a government or a corporation, where an interest rate and the payback time (called Maturity Date) are set in advance.

The creditor (those who purchase the bonds) will get interest payments from the issuer over time. When the maturity date comes (i.e., after five years), the issuer will return the money which you used to buy the bonds in the first place.

Mutual Funds

Source: Deemak Daksina

When a group of investors puts their money into one reserve, the pool of money is called a mutual fund. Portfolio managers then further manage the mutual funds, such as purchasing stocks, bonds, and other assets.

It is not uncommon for mutual funds to resemble indexes such as the Dow Jones Industrial Average or the S&P 500. Mutual funds are valued at the end of the trading day, so transactions such as buying and selling are conducted after the market closes.

Stocks

Source: Markus Spiske

Upon hearing the term ‘investment’, stocks might be an asset class you are most familiar with.

A stock represents a small part of a company’s ownership. Imagine pizza; buying a stock is like buying a slice. At least a very tiny slice of pizza. That slice is called a share. Those who purchase stocks generally target those that will go up in value. When a stock’s value increases, the investors can then sell them to gain profit. 

Stock ‘owners’ are called shareholders since they are entitled to a share of the company’s profits.

Are there alternatives?

Of course!

All things have alternatives, and investments are no exception. As you gain more experience and knowledge, you will learn more about other investment sectors, such as Exchange-Traded Funds (ETFs), Real Estate, Commodities, Private Equity Funds, and Hedge Funds.

In a Nutshell…

Educating oneself before doing anything is a must. This also applies to investing. The general rule of thumb is to avoid investing in an unknown area/sector. Consult with professionals and diversify your assets.

Good luck with your investments!

Author

Gamal Kevin Alega | @gamalkevin

A law graduate from Indonesia; currently living in Pekalongan, Jawa Tengah. Highly enthusiastic about languages, cultures, and technology. Joining AYO as a Content Writer with the intention of honing writing skills, as well as enriching connections from various cultures and backgrounds. A proficient eater with two decades of experience as well.

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