We’ve all heard someone claim they know the secret to investing. Or that they know the next thing to invest in to get rich quick. This sounds great, but you know there has to be a risk, right?
How do you know what you should invest in? How do you minimize risk?
Investing is like gambling. The odds are much more likely that you'll succeed in investing, but hear me out…
Think of roulette: there is a 47.37% chance that the ball will land on black and a 47.37% chance that it will land on red.
Similarly, there is a 47.37% chance that it will land on an even number, and the same chances that it will land on an odd number.
With less than a 6% chance of landing on either green or zero, you can make a pretty good guess that the ball is likely to land on a red or black color with an even or odd number almost always.
Of course, every once in a while, it will land on green zero, but since this is statistically infrequent, you don’t have to worry about this. It is just important that you do not bet too much at once!
Compared to investing, there are ways to make safe bets in the stock market. You typically don’t want to bet on the risky “green zero” opportunities that might make it big. These usually will not win for you.
Instead you want to diversify your money across some tried-and-true options that have more consistent success. This is your future after all and you don’t want to lose it on one bad bet!
Because you don't know when the roulette ball will land on an even black, or an odd red you ought to diversify your bets. Said another way, we know that there are some tried and true ways to invest, we just don't know which one will be the best each year.
There are several different types of assets that you can invest in including stocks, bonds, commodities, real estate and even cash. And there are many ways to diversify within these options as well. Here are some of the strong bets:
- Large Cap Stocks: These stocks are for companies with large market capitalization and they are typically the biggest companies in the world. Amazon, Google, and Microsoft would be considered large cap stocks. They are the least volatile stocks, and their returns will have slower ups and downs. However, they also have the most shares and they are typically priced high.
- Mid Cap Stocks: These stocks are from companies that are well-established but still growing. They are not yet the huge companies, but they might be one day!
- Small Cap Stocks: These stocks are for public companies that are still small and growing. They might not trade every day, and their stock returns are likely to go up and down much more dramatically than large or mid cap stocks.
Investing in a small or mid cap company is slightly riskier that investing in a large cap stock, but the potential returns are higher if the company does well. It would be like betting on green or zero in roulette.
You can invest in large, mid, and small cap stocks for domestic companies, but you can also diversify your bet further by investing in international options.
Company stocks can be purchased from both developed countries (maybe even more established compared to the US) and emerging countries (that are still growing).
Betting on companies in developed countries might give you a stable return while stocks from emerging companies can deliver a higher return (or loss) in exchange for higher risk.
Similar to stocks, there are options to invest in both domestic and international bonds.
Bonds are slightly less risky than stocks, because they are debt that needs to be paid out by the entity. But they will also typically have a lower return over time.
Be sure to see our other posts about Investing to learn more about bonds!
This can include gold, silver, wheat, barley, gas, and food – basically anything that people need to pay for.
People invest in commodities because the value can go up over time. For example in summer 1999 the cost of gold was around $260 per ounce. Today gold trades at $1515 per ounce!
You can include commodities in your portfolio to diversify even further.
We have previously talked about investing in real estate on your own, but if you haven't seen it, be sure to read that post too!
However, you can also invest in companies that own real estate. This is a unique way to add real estate to your portfolio without the work of owning additional property yourself.
One way to do this is called a REIT, which stands for Real Estate Investment Trust. These companies purchase real estate and are required by law to payout a certain percentage of the cashflow and profit to shareholders.
The value of cash typically doesn’t change too quickly, so holding cash might not a great investment growth strategy. But if the market crashes, your money is still money. The stocks may not be worth as much anymore.
Additionally, some investors like to keep cash on hand so they can buy into the market or real estate when they see opportunity.
Investing in only one of these options is like betting on the green zero – if you are right you will win big, but if you are wrong (likely!) you can lose everything.
Its best to allocate your portfolio across multiple options to take advantage of the growth of many without having to worry about the few that might not make it.
With a diversified portfolio you will be the winner in the end!