The Financial Instruments

You’ve got to think about big things while you’re doing small things, so that all the small things go in the right direction.
Alvin Toffler, American futurist and businessman, known for works discussing digital and communication revolution

There are many different instruments that you may use to invest in. The following article will explain to you in more detail which possibilities you have to invest in a certain asset class among the advantages and disadvantages of each instrument.

instruments

1. Which financial instruments can I use to invest in Cash & Cash Equivalents?

Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value
Warren Buffett, American investor, CEO of Berkshire Hathaway, considered one of the most successful investors in the world

For novice investors there are following options:

  • Physical cash is easy to be stolen and does not give you any return. Worst case you forget where you put it. In the age of online payment and credit cards you should have as much cash as you need with you but not more. Maybe if you travel some cash as a backup.
  • Money in the bank account is the less risky possibility to invest. However, the interest rates are very low currently and inflation is picking up. You should always have some money in the bank in case of emergencies and upcoming investment possibilities, but you will not increase the value of your portfolio by putting your money on the bank account.

For investors with investment experience in private context there are some more alternatives:

  • Short Term Governmental Bonds are bond issues with by the government and have a very short due date, e.g. 30 days. Therefore they are nearly as liquid as cash.
  • Short Term Bond Funds are funds that invest in bonds, which have a very short due date, e.g. 30 days. Therefore they nearly are as liquid as cash.
  • Treasury bills (or T-bills) are similar to bonds that do not pay interest prior to maturity. Therefore, they are sold at a discount of the par value. They are issued directly by the US and UK government and mature in one year or less.

2. Which financial instruments can I use to invest in Bonds?

Market participants care first about interest rates, exchange rates, bond prices and the one great factor that affects all three: the long-term solvency of a bond company called the U.S. government.
Amity Shlaes, an American author of three New York Times Bestsellers and recipient of the Bastiat Prize.

For novice investors there are following options:

  • Bond ETFs (Exchange Traded Funds) have low transaction costs and are well suitable if you want to invest in bonds.

For investors with investment experience in private context there are some more alternatives:

  • Bond Funds are funds that invest in bonds, which have a due date of more than 30 days.

Investors with investment experience in a professional context can also invest in:

  • Single Bonds, but as there are many different sorts of bonds, we suggest to buy established bonds of companies and governments, if you are not an expert.
  • Bond options are a derivative that gives the buyer the right (but not the obligation) to buy the bond at a later point of time at a previously defined price. For further information look up options.
  • Bond futures are futures that use bonds as an asset. For further information look up futures.
  • Bond CFDs are CFDs that contain Bonds in the contract. For further information look up CFDs.

For Full-time professional Investors there are some more instruments out there:

  • Bond Swaps are Swaps where bonds are exchanged. For further information look up swaps.
  • Bond Hedge funds are hedge funds that invest in bonds. For further information look up hedge funds.

3. Which financial instruments can I use to invest in Equities?

Equities are boring; bonds are disgusting.
Jeremy Grantham, British investor and co-founder and of Grantham, Mayo, & van Otterloo (GMO), started one of the world's first index funds in the early 1970s

For novice investors there are following options:

  • Stock funds are funds that invest in stocks. Stock funds are an easy alternative to buying several single stocks however management fees will occur that will reduce your returns. For further information see stocks and funds.
  • Equity ETFs have low transaction costs and are well suitable if you want to invest in stocks. This is our pick if you want to take advantage of low transaction fees but have the full potential of the stock price increase. However you do not owe the stock itself, therefore you have to make sure that the ETF is physical and that you will benefit from dividends.

For investors with investment experience in private context there are some more alternatives:

  • Single Stocks are fractional ownerships of a corporation. If you buy single stocks please make sure that you buy different ones to diversify and reduce the risk. Stocks of large caps are usually safer than the ones of small caps and offer the possibility of good gains if you are able to assess the current market conditions correctly.
  • Stock CFD (Derivative) are CFDs that contain stocks in the contract. For further information look up CFDs. CFDs are complex, we suggest only to deal with them if you know what you are doing!

Investors with Investment experience in a professional context can also invest in:

  • Stock Options (Derivative) are derivatives that give the buyer the right (but not the obligation) to buy the stock at a later point of time at a previously defined price. For further information look up options. Options are complex. We suggest only dealing with them if you understand them well!
  • Stock Futures (Derivative) are futures which use stocks as an asset. For further information look up futures. Futures are complex. We suggest only dealing with them if you understand them well!
  • Stock Swaps (Derivative) are Swaps where stocks are exchanged. For further information look up swaps. Swaps are complex. We suggest only dealing with them if you are a real expert!

Full-time professional Investors can also invest in Stock Equity Hedge funds. Stock hedge funds are hedge funds that invest in bonds. For further information look up hedge funds. Hedge funds are not open to private investors, you need to be a full time professional.

4. Which financial instruments can I use to invest in Real Estate?

Perhaps the secret to making a billion dollars in real estate is that there is no secret.
David Lichtenstein, American billionaire entrepreneur and real estate investor, founder of The Lightstone Group

When you want to invest in real estate, you should bring some experience. There are two main options to invest in real estate:

  • Owning your own property, where you own and manage the property. This comes with a lot of work but you are the boss!
  • Investing in a real estate investment trust (REIT), meaning giving money to companies to develop real estate that returns profits for you.

When you want to own your own property, you have the following options:

  • Cash financing usually only makes sense if you don't know where to put the money elsewise. You want to have a safe income and you are not much concerned about the rate of return
  • Building Loan: When you get a loan for real estate you have the huge advantage of leverage. Financing real estate through a lone gives you a high return on the capital employed as you can use the loan to leverage your own money. Let’s explain this with an example. When you buy stocks worth 100.000 USD, your gains will be counted as a percentage of the 100.000 invested. When you put 100.000 USD in a house and get a credit worth 900.000, your profit is made in relation to 1.000.000 USD but you only put in 100.000 USD. The security is the house, therefore the bank will give you the loan. The bank will not give you a loan if you just invest in stocks as there is no security. For sure this investment comes with a lot more work than buying stocks! Think well about it! It is a great option if you are willing to put extra effort. Also, you will need a good credit statement and some initial amount of money.
  • Housing savings contracts give you support from your government if you put in some money. This makes especially sense when you are young or if you want to create savings for your children.

Furthermore, you will have to decide on which kind of real estate you will invest:

  • Residential real estate investments, where the income comes from the rent of the people who live in the real estate
  • Commercial real estate investments, where the income comes from the rent of the companies that rent the office space
  • Industrial real estate investments, where the income comes from the rent of the companies or the people that use the space, e.g. warehouses, distribution centers or manufacturing or assembly plants
  • Retail real estate investments, e.g. shopping malls where the income comes from the rent of the shops
  • Mixed-use real estate investments, where there is some of the above mentioned combined, e.g. a residential area with office space and shops.

5. Which financial instruments can I use to invest in Commodities?

Commodities tend to zig when the equity markets zag
Jim Rogers, American businessman, Chairman of Rogers Holdings and Beeland Interests, Inc., co-founder of the Quantum Fund and Soros Fund Management

Novice investors should not focus on commodities. Investors with investment experience in a private context can go for a physical purchase of commodities. Gold is the most popular commodity, but you can also invest in silver or other metals. Gold is very liquid and many countries offer tax advantages on returns made. Unfortunately in the US capital gains made with physical commodities are taxed at 28 percent. If you go for more complex commodities you should really be familiar with the commodity.

For investors with investment experience in a professional context there are some more alternatives:

  • Commodity Certificates (Derivative) are derivatives that have a commodity as underlying. For further information look up certificates.
  • Commodity Options (Derivative) are derivatives that give the buyer the right (but not the obligation) to buy the commodity at a later point of time at a previously defined price. For further information look up options. Options are complex. We suggest only dealing with them if you understand them well!
  • Commodity Futures (Derivative) are futures which use commodities as an asset. For further information look up futures. Futures are complex, we suggest only to deal with them if you understand them well!
  • Commodity Swaps (Derivative) are swaps where commodities are exchanged. For further information look up swaps. Swaps are complex. We suggest only dealing with them if you are a real expert!
  • Commodity CFD (Derivative) are CFDs that contain commodities in the contract. For further information look up CFDs. CFDs are complex, we suggest only to deal with them if you are a real expert!

For full-time professional Investors there are Commodity Hedge funds. Commodity Hedge funds are hedge funds that invest in commodities. For further information look up hedge funds. Hedge funds are not open to private investors, you need to be a full time professional.

6. Which financial instruments can I use to invest in Modern Investments?

Bitcoin will hit thousands of dollars per coin, because it's worth at least that much, or it's worth zero.
Erik Voorhees, American startup founder, co-founder of the bitcoin company Coinapult and bitcoin gambling website Satoshi Dice, was fined by the U.S. Securities and Exchange Commission for an unregistered stock offering related to SatoshiDice

We do not suggest anyone to go into modern investments if they are not willing to take the full risk of losing the whole investment. If you are willing to take the risk, you can go into:

  • Crowdfunding gives you the possibility to invest in new ideas or companies. However, there is a huge risk the company will not turn profitable and all your money is lost.
  • Digital money/Cryptocurrencies are on the market for a couple of years and have seen a hype in recent years. There is no regulation and the companies usually do not even have a proper legal form. Investments are of high risk.
  • There are probably a million other investment possibilities in the niches of the internet, e.g. you can invest in digital property in the game of second life. If you are an expert in one of these and you want to take some risk, you are free to do so. However, this is not part of a profound long-term investment strategy.

7. Which financial instruments can I use to invest in Passion Investments?

I really just started buying art as a passion. I never considered it an investment, but it ended up being a good investment.
Daniel S. Loeb, American investor, founder of Third Point, a New York-based hedge fund focused on event-driven, value-oriented investing

You are best in what you love doing! Investing in what is your passion can be very rewarding. You can use your special knowledge and combine it with making money. Also, it gives a good diversification. The downside is, that you must know what you are doing as you might fall for frauds and fakes or hidden costs. Passion investments include:

  • art
  • classic cars
  • stamps
  • coins
  • watches
  • wines
  • instruments
  • jewelry
  • diamonds
  • antique furniture
  • Chinese ceramics

The Knight Frank Luxury Investment Index gives an overview of possible passion investments. Over the last years especially wines and cars showed great performance. However, your investment should depend on your knowledge! The following graph shows an analysis of the past years on passion investments.

A graph that shows the return of alternative investments like ceramics, antique furniture, diamonds, stamps, cars, jewelry, coins, watches, art and wine

8. Summary

infographic explaining the investment instruments

In the following, we give you a summary of the different asset classes:

Overview of instruments in different asset classes
Asset Class Types
Cash & Cash Equivalents Physical Cash, Bank Account, Money Market Funds, Short Term Governmental Bonds, Short Term Bond Funds, Treasury bills, Commercial paper, Foreign Currency (FOREX
Bonds Single Bonds, ETFs, Mutual Funds, Derivatives (Certificates, Options, Futures, Swaps, …)
Equities Single Stocks, ETFs, Mutual Funds, Derivatives (Certificates, Options, Futures, Swaps, …)
Real Estate Own property, REIT
Commodities directly through Futures, indirectly through stocks, ETFs, ETNs, Mutual Funds and Index Funds of commodity companies
Modern Investments (Alternative Investments) e.g. crowdfunding, bitcoins, digital property (land in second world, characters in role games, ...), carbon credits, venture capital, film production
Passion Investments (Alternative Investments) e.g. art, classic cars, stamps, coins, watches, wines, instruments, jewelry

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