Director of a construction company, Mr. John Smith is an old-fashioned man, a holder of shares of APPLE and Alphabeth Ink. He receives a steady small annual income and high dividends.
A student of Economics Piter Rogers has recently learned about Forex and started to trade crypto-currency; once he earned 200% profit from on his investment.
At the same time his father, Alan Rogers, invests in the hedge fund and receives average profit bearing average risk. He is sceptical about his son’s undertaking, as he thinks that his son cares about the profit and does not consider possibility of losses.
Each of these people is an investor, but they have different targets and approaches to risk.
What is the difference between their targets and risks?
Various approaches to investment activity and expected results
- conservative — low risk and low return;
- aggressive — high risk and high return;
- moderate — medium risk and medium (or sometimes high) return.
Volatility (variety in price) of different assets
Risk level depends on the average risk of all your assets, which constitutes your investment portfolio. What are types of portfolios?
Conservative portfolio: low risk, low return
Such portfolio is made of cheap and slow-growing assets, which are however, risk-free. These can be securities, assets of government companies, some large and reliable private companies, which do not like innovatization. These companies are manufacturers and suppliers of goods and services, which have stable demand. Successful activity of these companies largely depends on the country’s economic growth but not on market competition. As an example, we can see Procter & Gamble Company (P&G), one of the largest multinational manufacturers of consumer goods.
Let's assume that on 23 December 2011 you bought 1.000 shares of P&G at a price of $66.67, which amounts to $66670. Within 5 years your biggest loss amounted to $6840 (11.26%), and it happened on June 22, 2012, when the price of assets fell to $59.83. The maximum profit was $26790 when you sold your shares at the price of $93.46 on 24 December 2014. It happened 3 years after you had bought these assets, which means that over three years your total profit would be about 28.66% (unadjusted for inflation and with fairly low risk).
Another example of investment with low risk and low return is a Bank deposit. In USA average interest from such investment is about 0.5-1.15%. Interest in the most world banks is slightly higher. The good interest is provided in the banks of Cyprus, which is from 4.5 to 6%. And the highest interests is in Russia - from 8 till 12% per annum. Latvian banks Bigbank and Citadele offer from 2 to 3.5%, US Jones Vanguard Group pays off only 2.96% to foreign investors. You can invest in mutual Funds with the interest of 15-17% per year.
Conservative trading strategies in Forex markets guarantee you high annual revenue (up to 30%) but also a higher risk compared with investments into government securities or a bank deposit.
Growth portfolio: high risk, high revenue
Such portfolio consists of assets, which are still cheap, but rapidly increasing in price. Traditionally, these are assets of the young and promising companies. Such portfolio can bring large profit in the medium or long term with high risk and low or zero dividends at present. One of the examples of such startup is a decentralized payment system Bitcoin, the issuer of the Bitcoin currency; the rises and falls of this currency depend only on supply and demand.
The currency Bitcoin has soared up magically.
In 2011, an American investor, who had disappointed in the prospects of crypto-currency, bought two pizzas and paid 10 000 BTC (about $25) for them, which at that time equaled to $0.0025.
In July the rate has increased to 0.080 USD, so it meant that $25 became equal to $800. In November the rate was $0.5, the price of the pizza has grown to $5.000. The man became a mockery; but it was not the end of the story: in accordance with today's exchange rate the pizzas cost about 9 million USD, which was by 360 thousand more than the initial price. Since then, May 22 became Bitcoin Pizza Day when bitcoin’s traders and investors eat pizza and treat their friends and family with pizza.
There are many other crypto-currencies in addition to Bitcoin, which can grow. However, investors shall be take into account that price volatility of this asset depends only on supply and demand. No one can guarantee that such assets will go up. This fact does not prevent from earning money in the short-term, which is taken into advantage by many speculators and traders.
Balanced portfolio: medium risk, average or high revenue
This type of portfolio is the most popular among large investors, including government. A balanced portfolio consists of assets with high volatility, assets of young firms (startups) and conservative companies. This strategy helps to diversify risk, that is, market risk is divided between various assets of different maturity, risk and revenue. Some assets will bring long term revenues, others - steady income and dividends, while the latter assets may bring either high profit or zero. The ratio between these three types of assets is decided by an investor and depends on the market situation, investor’s attitude to risk and targets in general.
First of all, an investor shall make decision about conservative assets, which grow slowly but steadily and which are under the guarantee of large and reputable companies. Revenue of such assets in blue chip will be amount to 5 - 7% per annum. These are assets of such companies as Google, Microsoft, P&G, Apple and Alphabet Inc, which constitute portfolio of our Mr. John Smith. Low interest - low risk. It also refers to bank deposits and mutual funds
Behavior of Google stocks in the past 5 years
An investor shall make decision on the moderate assets. They usually do not fall in price in the long- term, but they may rise or fall seasonally, which makes it difficult to sell them any moment.
These assets include real estate, gold, public bonds of some developing countries and blue chips of the developed countries.
Return on ten-year government bonds of Russia has dropped to many-year highs, giving investors a chance to buy them at a low price
Aggressive assets are crypto-currencies, stocks of the young companies and startups, bonds of the developing countries (BRICS), such as Brazil, India or China. Investments into such assets require from an investor a lot of thinking and consideration; (it will be useful if he/she knows some commercial or government secrets to make sure that the assets will definitely bring profit!) Price volatility of these assets is very high, which means that you can earn up to 200% per annum, or lose 70-80%.
An investor, who makes up a balanced portfolio, estimates risks with the account of current market situation and his/her own targets; therefore, the ratio between different assets can vary. Remember, that traditionally a ratio is 50% of conservative assets, 35% of moderate assets and 15% of aggressive assets. However, an investor can adjust this ratio in accordance with his/her expectations.
Handy tips
- You reap what you sow: Learn more about the finance world, continue to increase your knowledge and become a competent expert. We cannot give you an example of anyone who became a millionaire just investing into the bank deposit. Different assets can be useful in different circumstances and times. Therefore, take time to explore all possible options.
- Put trust in professionals. If you cannot be involved into investment activity for some reasons, you can entrust this task to a professional Manager. Nevertheless, even in this case, it is important for you to know the basics of money management in order to find a competent Manager.
- Protect your investment against market risks. Even a very aggressive portfolio should be carefully controlled and revised from time to time. You should have at least +50% of the alternative assets to replace those, which, for some reason, you find unreliable. An investor shall not expect high profits out of nothing; make a thorough investment plan, think about risks and try to avoid losses, after that you can think how to make big money!
When you purchase assets you do not just pay money.
According to Warren Buffett: it is better to buy great assets at a reasonable price, than reasonable assets at a great price.
It is better than to exchange even the most hopeless assets for a pizza.
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