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Choosing the Right Asset Class When Trading

Your capital may be at risk. This material is not investment advice.

Asset allocation is a term used to describe how funds are split into different asset classes. When looking at making investments, picking the right asset class is one of the most important decisions you can make.

If you’re an investor below the age of 45, a good rule to go by is having a portfolio that is 80 to 90% invested in stocks and 10-20% in bonds.

With this particular ratio, there’s a long time until retirement. This allows you to buffer any volatility in the short-term while reaping the long-term rewards.

If you’re closer to retirement, the mix is more likely to be 50/50 of stocks and bonds making up a portfolio. This caters for expenditures both right now and in the future.

Having more bonds in your portfolio and a lesser amount of stocks means you have a lower volatility risk. This also provides an amount of downside protection against bigger losses.

Types of Asset Classes

There are a variety of asset classes — both traditional and alternative — that you can choose to include in your portfolio. They are as follows.

Traditional Assets:

  • Stocks
  • Bonds
  • Cash

Alternative Assets:

  • Commodities
  • Real estate
  • Foreign currency
  • Derivatives
  • Venture capital
  • Special insurance products
  • Private equity

There are more than enough asset classes to pick from above. Most regular investors will offer a combination of both asset classes made of stocks and bonds. More than anything, it’s important to just begin investing.

Achieve the Right Balance of Stocks and Bonds

The majority of investors can reach the goals they want by combining stocks and bonds in the correct way.

So how do you decide to pick how much of each class?

If you’re looking for a return that is higher but poses a high risk, then going for stocks is what you should invest your money in. In a short period of time, stocks exhibit great volatility. Over the long term, however, they usually recover.

An investor who isn’t willing to take risk may choose to avoid a majority in stocks because of the short-term volatility. In this case, they would opt for a majority in bonds. However, bonds have a much lower return.

The higher the risk taken, the better the rewards are for profit. Equity risk in the long term is often acceptable for investors to take.

What to Consider in Choosing Your Stocks

There are a large number of characteristics that you need to be aware of when weighing up a stock.

You can consider five of the most important aspects as dividends, P/E ratio, historical return, Beta, and earnings per share. Below is a little more information about each.

Dividends

Dividends are a great way of boosting your earning potential. They allow companies in the public sector to offer rewards straight to shareholders.

The amount they pay out and how often they pay out is entirely up to the company.

These variables are driven by how well the company is doing but are not necessarily limited to cash. Companies may choose to pay shares in the form of more shares, whereas companies that are more established will usually pay dividends.

They will do this because they’ve gotten to a level where they can give shareholders more value via payments, rather than adding to the infrastructure of the company.

P/E Ratio

P/E ratio, or the price to earnings ratio, represents the valuation of the share price of a company compared to how much it is per share.

This figure can be found on the majority of financial reporting sites. The value of this figure should be observed, as it gives investors the best idea of a company’s stock.

If the ratio is a figure of 15, this will tell us that any investors would pay $15 for each $1 the company earns over the course of a year. This means that the higher the ratio is, the more you can expect from the company. This is a direct representation of how much faith investors have in the potential of the company.

Beta

This measurement is a representation of how volatile a company is compared to the market in totality. The value of one means that volatility is the same as that of the market on the whole.

Stock with any figure lower than one means it is less volatile and anything above is more volatile. For example, if a company had a beta score of 1.5, it would mean that it is 50% more volatile than the market average.

Beta is not only a great figure to be aware of in owning stocks, but also if you want to not be privy to the effect of swings in the market.

Earnings Per Share (EPS)

This is a dollar figure that shows how much of any companies earnings are allocated to the share of common stock.

Essentially, any amount of money not paid out in dividends by a company is divided by how many shares they have left. This number can be used to work out how capable a company is of giving back value to shareholders.

The higher the EPS, the higher share prices are. Any company that cannot deliver forecast on earnings may be a risky company for an investor to put money into.

Historical Returns

Investors can become interested in certain stocks after reading news about how they have performed. The problem with this is that performance can be short-term.

Looking at how a company has performed in the past can help you see whether an investor’s risk assessment is sound. It’s good to look at how a company has performed within the last year, but it’s not a guarantee of returns in the future.

What’s the Right Asset Class for You?

Picking the correct asset class is vital to mitigate risk when investing. Optimizing your portfolio for your own needs is also very important. Take time to work out the best stocks and bonds for you to ensure an outcome that is the most beneficial.

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Author info:
The Hoth
Author: Kungawo
Kungawo is from: South Africa, Cape Town
Please be advised that certain products and/or multiplier levels may not be available for traders from EEA countries due to legal restrictions