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Five Kinds of Investments and How to Use Them

Thursday, April 14, 2022 12:55 PM | Nick Dey
Five Kinds of Investments and How to Use Them

One of the first things that new investors learn is that at different stages of life, the goals of investors vary widely. Older investors lean more toward the wealth preservation side, while younger investors set their sights on wealth accumulation.

They also learn that, regardless of the stage of life, they must also pay attention to the economic cycle and navigate inflation, recessions, and bull and bear markets.

For many, particularly newer investors, this means different kinds of stocks from different sectors that carry different sets of risks.

But others choose to diversify outside of the realm of stocks to maximize security, profit, or growth potential. From cryptos to bonds, new investors would be wise to know these kinds of investments to help maximize their efforts given their time horizon and the current economic cycle.

Stocks

The stock market, home of Elon Musk-mania and GameStop’s Reddit apes, is by far the most common investment. Investors buy shares of a company, that over time, hopefully, appreciate. And, for the most part, they do.

Stock investors pay attention to earnings dates and dividend dates and yields while keeping up to date on news and having their eye on “what's next”.

With the immense diversity in the stock market, investors can build a pretty well-diversified portfolio solely in the stock market as dividend stocks and mega-cap stocks provide security while growth stocks bolster growth for younger investors.

Further, there's a stock for pretty much every market, as there tends to always be some industry profiting off of current situations.

Cryptos

The cryptocurrency market, as it is now, couldn’t be much different from the stock market. It is extremely volatile and tends to do well during times where 1) retail investors are involved and 2) when growth stocks tend to be performing strong.

Bitcoin’s 40-day correlation with the tech-heavy Nasdaq hit a record high of 0.6945 last Friday. Meanwhile, Ethereum’s three-month correlation with the Nasdaq is 0.68. These figures suggest a pretty strong correlation between tech stocks and the two largest cryptocurrencies.

With Bitcoin and Ethereum representing just over 60% of the crypto market, don’t expect cryptos to be an “any market” kind of investment destination any time soon as there isn’t really a kind of crypto that tends to outperform during bad growth markets.

Bonds

Bonds are an entirely different beast altogether. Bonds are sold by governments and companies in order to secure financing for some investments. A bond is essentially a contract between the issuer entity and investor where the issuer is borrowing money for a set amount of time and agrees to make regular interest payments along the way. These regularly scheduled, generally fixed, interest payments are why bonds are often called "fixed-income" investments.

Bonds, particularly government bonds, tend to become a heavy portion of your portfolio as you age. While this rule is disputed due to rising life expectancies and lower bond yields, the Rule of 110 is a well-known rule for helping investors decide how much weight to put in bonds.

This rule subtracts 110 by your age to get your stock weighting. At 50, for example, the rule suggests that you’d want 60% in stocks and 40% in bonds.

Derivatives

Derivatives are another kind of market that can be diverse. Derivatives are financial instruments such as options and futures contracts.

In derivatives, there are four kinds of participants: hedgers, speculators, arbitrageurs, and margin traders. In short, hedgers sacrifice some profit to reduce risk, speculators look for outsized rewards, arbitragers take advantage of price differences, and margin traders collect the payments for selling the derivative contracts.

Derivatives add a lot of risks and potential rewards to your portfolio and can be all-or-nothing, so be sure to research a lot and fully understand the risks carried by each trade.

Commodities

Lastly, we have the commodities market. This is literally everything from futures contracts on barrels of oil and coffee, to straight-up buying gold.

These futures contracts represent the price that these commodities will be delivered for at some date in the future. This market isn’t for everyone, but investors can capitalize on spiking and surging commodity prices here.

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