Asset Allocation Basis Part 3: Invest in the Market when People have Chickened-out

Dealing with increased volatility has now become a part of investors’ daily routine. As of 2008, the stock market has become the  most volatile we have ever seen, some have even taken to calling them “violent”. I guess this is why most people have fled the equity scene to invest more in fixed income choices and don’t want to hear about investing in the stock market. However, the stock market was, is and will be the best place to encourage your investments to grow.

There are several types of investment to consider when you want to purchase a piece of a public company. Today, we will be reviewing the most common asset classes related to stock. We will take a look at how we invest our money into them in a later time.

What is a Stock anyway?

In order to gather cash to finance business growth, companies basically have 3 options:

#1 They borrow money from a bank like an individual and offer guarantees to back the loan.

#2 They borrow money from the markets (by issuing corporate bonds). This is very similar to borrowing from the bank but individuals or other companies are creditors instead of a normal bank.

In both these cases, the company has to manage a defined interest rate and its accompanying repayment schedule. Sooner or later, it will have to pay back the debt.

#3 They issue shares (usually a small part of the corporation) and sell them to the public (through the stock market in an IPO: Initial Public Offering). Therefore, each individual can buy a tiny part of a company through the purchase of stock. Shareholders (those who have purchased the company’s stock), will gain benefit from:

#1 the company growth (as the stock will be worth more and they can generate a capital gain by selling)

#2 through dividends (the company may decide to share their profits with shareholders instead of reinvesting them).

So when you buy stocks, you actively participate in the growth of a company while it doesn’t have to pay you back. You are buying a part of a company in the hopes of seeing it make more profit in the future so you can sell it with a profit of your own.

The great news is that you are no longer limited to buying companies from your own country. You can also buy foreign companies (such as BMW that is not listed on the US market for example).

International Stocks

International stocks are a great option if you want to diversify your portfolio and hold companies that are not directly influenced by the US economy (which is still hard to find since the US consumer makes the world economy turn…).

However, you can benefit from another country’s economy that will make the company grows faster. Just think about the Canadian market and their banks. Investing in Canadians banks is certainly something to consider these days…

However, you must keep in mind that it adds an additional risk; currency risk. Since you are buying foreign country companies, you have to buy them in another currency. For example, you take $1,000 to buy Canadian Banks in Canadian dollars and the US dollar goes up. Your $1,000 Canadian dollars may only be worth $900 in US dollars down the road. Even though your investment is still worth $1,000 (i.e. it didn’t lose its value on the stock market), if you sell it and convert your money back, you will lose $100.

Emerging Markets

Emerging markets is a really interesting asset class. They are more commonly known as the BRIC (Brazil, Russia, India and China). To those emerging markets, you can add Venezuela, Turkey, Vietnam, etc.

These are countries with strong but unstable economic growth. Since companies are growing at a ridiculous pace, it is hard to predict their long term stability. This is why you can get a very nice yield overtime but the fluctuation of your portfolio will be greater than what you would experience on the US market.

Nonetheless, it is interesting to have a part of your portfolio invested in emerging markets.

Questions about the Stock markets? Please send me an email at thefinancialblogger (at) gmail (dot) com.