Investing in your future is something you may be thinking seriously about. If you feel you are ready to take the next step and begin investing your capital in particular assets, then make sure you have a solid understanding of these three investment concepts before you begin.
Diversification is the act of investing your capital in a range of different investment products, with the aim of trying to mitigate your risk. By not investing all your capital in one particular product, you are reducing your exposure to volatility. A common explanation to help illustrate the purpose of diversification is the old saying; “don’t put all your eggs in one basket”.
Within investment, risk is defined as the inherent degree of uncertainty (or probability of capital loss) associated with a particular investment product. The general rule of thumb is that the higher the risk, the higher the potential reward, whereas; the lower the risk, the lower the potential reward.
For example, investing in Foreign Emerging Markets is often considered a high risk investment. If a foreign economy is experiencing a period of rapid and substantial growth many investors will want to pile their money into its government bonds or particular company stocks because there is a potential for high return on their money. However, the reason it is so risky is because there are so many unknown variables that could have an adverse effect on the investment. For example, there may be sudden political unrest, or the economic boom may be much more short lived or unsuccessful than investors were expecting. This means there is a high probability that they will lose their initial capital.
In contrast, government bonds from large, stable, and established economies are generally viewed as one of the lowest risk investment options available. Whilst they do not pay back high returns on an investor’s capital, they are much less likely to default and cause the investor to lose their money.
Liquidity is a term used by investors to describe how quickly an asset can be bought or sold, at a price that reflects its real value.
Cash is seen as the most liquid asset. It is easily tradable for almost any asset on the market, and its value is clear and immediately recognisable. For example, if you wish to buy a computer that is worth €500, then it is easy to trade €500 of cash for it and can be done very quickly.
However, if you are the owner of an original Monet, whilst it may be extremely valuable, it can be difficult to find a suitable buyer who is willing to pay you the price that it is worth. It may take you months or years to convert the asset into its true cash value. This means that your piece of priceless art is an illiquid asset.
These three concepts will be key to your investment journey. Take the time to understand them, and find out even more about investment and further financial education in our other blog posts here.
Your capital is at risk, and past performance may not be a reliable indicator of future results. Oval Money is not permitted to provide financial advice, and if you have any questions please consult an expert.