Cash, bonds, and equities… Do you know the differences among these three investment classes?

Wednesday: The Independent Investor FROM THE DESK OF MILES EVERSON: Last week, we talked about a particular investing discipline, which is… Balance investing to fit you. We explained the different asset classes and asset allocation to help you invest your money wisely. Today, we’ll dive deeper into the three asset classes we mentioned last week to know more about the investment type that caters best to your lifestyle and spending habits. Keep reading to know more about the differences between cash, bonds, and equities in terms of investing your money. CEO, MBO Partners Chairman of the Advisory Board, The I Institute

Cash, bonds, and equities… Do you know the differences among these three investment classes? American investor Seth Klarman once said, “We all know people who act responsibly and deliberately most of the time but go berserk when investing money.” “It may take them many months, even years, of hard work and disciplined saving to accumulate the money but only a few minutes to invest it.” We’re now at the part of investing that requires upfront time and thought with your own periodic review. So, as mentioned last week, there are three main asset classes with which you can invest or allocate your money: Cash, Bonds, and Equities. Here’s a breakdown and analysis of these three things: Cash and Bonds Park Wealth. The money that you will need to spend in the very near future is best kept in no-loss or low-loss investment channels. In other words, this type of money is best put in cash-like savings, bank accounts, etc. so that at any time that you will be needing the money, you can easily get it. … but here’s the thing. The problem with this channel is that they ALMOST never pay more than the inflation rate. For example: If the bank is paying you 2% interest rate, the inflation rate is more likely only 3% or a little bit higher. If the interest rate is at 5%, then the inflation rate is probably 7% or higher. [Interest Rate: The amount a lender charges for the use of assets expressed as a percentage of the principal amount. Inflation Rate: The percentage increase or decrease in prices during a specified period.] In this case, while it looks like you’ve made a lot of money at the end of a year, in reality, you are able to buy less stuff because of inflation. “You lose money by keeping your money in cash-like accounts. The only benefit is that they are unlikely to fall much in price.” If you’re the type of person who loves to have tremendous increases in your investments, then this channel is not the appropriate one for you. Bonds are Not Much Better. Unlike cash-like savings, bonds often pay a rate of interest above inflation and generally preserve your capital. However, the amount they pay you over inflation is relatively insignificant compared to the return stocks pay you get over long periods of time. The bottomline? If you just need to “park” money that you will need to spend in the near future, this no-loss and low-loss investment channel is good for you. … but if you’re the type that likes to generate significant returns for your investments, then bonds are also not the one for you. Equity is King. While the three asset classes seem like three balanced choices depending on your spending habits, only one of them is a good choice for generating wealth and building your investments. That’s why equities, also known as stocks, is the best choice! According to another American investor, Peter Lynch: “If you hope to have more money tomorrow than you have today, you’ve got to put a chunk of your assets into stocks.” Lynch also further explained why stocks is a better choice than bonds: “Whereas companies routinely reward their shareholders with higher dividends, no company in the history of finance, going back as far as the Medicis, has rewarded its bondholders by raising the interest rate on a bond.” Here are a few more notable quotes from other great investors: “Prefer stocks over bonds. Bonds will limit your gains.” - Walter Schloss “If I had the choice between buying the S&P 500 Index or buying the 10-year US Treasury, 30-year US Treasury, it wouldn’t take me a nanosecond to go into stocks.” - Warren Buffett Clearly, while there is still a need for putting your money into bonds or other cash-like savings, the best investment choice remains unchanged. Business ownership and equities should still be maximized. There are some misconceptions that stocks are risky and bonds are safer. Another misconception says that younger people should invest in stocks while older people should invest in bonds. That shouldn’t be the actual case here. Don’t focus on which asset class is risky and which isn’t. Put the risk on something else, like the risk that you can lose money. If you think about it that way, you’ll realize that for long periods of time, bonds and cash-like savings are very bad for wealth creation. Remember that in investing, your age doesn’t matter. If you’re 60 years old and you don’t plan on spending your money until you're 75 or 80 years old, then that money should be put into equities. On the contrary, if you’re 25 years old and you need money to spend in 9 months time, then it’s better to put it into cash-like savings. See? It’s not really a matter of age but a matter of your spending needs and life choices. So, save as much money as you can right now. The longer you won’t need to spend that money in the near future, the more you’ll have for investing in stocks. Hope you’ve found this week’s insights interesting and helpful. Follow us on LinkedIn. Stay tuned for next Wednesday’s The Independent Investor! Learn more about securities in investment on next week’s The Independent Investor!