The five key questions about diversifying your investments
When deciding what to do with your savings, there are several aspects that will determine your investment profile. The first thing we should ask ourselves when making our investment decisions is the term of the same, that is to say, when we want to recover our money.
In the background, we must consider whether we are capable of assuming losses or, on the contrary, whether our objective is the preservation of capital. In addition, your investment, or rather your investment portfolio, must be somewhat diversified so as not to take unnecessary risks. In this respect, it should be noted that at least 10% can be used for high-risk investments.
Once we are clear about these two variables, we can begin to assess which asset class to invest in, but most importantly, look back at which markets can best meet our needs.
1️⃣ Is stock market performance really that profitable?
The market par excellence when it comes to investing has given us great joys, but also great failures. On many occasions, equities have been sold to us as a medium-risk market in which, in the long term, there are always gains. But this is not necessarily true. Since the outbreak of the financial crisis, the evolution of the main European indices has experienced strong volatility and therefore high risk. And the economic recovery has not returned them to a path of stability in the medium and long term.
In 2014 the IBEX35 traded at around 10,000 points, and at the beginning of 2019 it did not reach 9,000, in a process of GDP growth of an average of 3 percent over the same period of time, and with an increase in consumer prices of 2 percent. Likewise, the Eurostoxx50 index, the index that includes the 50 largest capitalisation companies in Europe, continues to trade at the same levels as in 2014.
When it comes to choosing equities as an investment object for the diversification of our portfolio, we can choose Funds that only invest in the stock market. These funds can be differentiated into two types: those that mimic the behaviour of an index, that is, that replicate the weighting of the index in their portfolio so that it has the same return, called passive management funds; and those that choose stocks of companies from different markets to try to obtain a higher return than a reference index could obtain, called active management funds. In any case, to buy shares in Investment Funds is to cede the management of our money to third parties.
On the other hand, there is the possibility of investing in specific shares of listed companies and making our own 'fund' managed by ourselves. If you have a capital preservation profile, it is important to be clear about the company's business model, which is solid and consolidated, which generates recurring profits, as well as a geographically diversified business. In the event that we want to take more risks, we would go to companies in the process of expansion, of new creation, or in the process of restructuring, where the potential profits could be very high, but we could also lose a large part of the capital invested.
This type of market has become a place for experienced investors with a lot of cold blood, and depending on the profile we have, perhaps it is better to leave it to the professionals of the financial sector.
2️⃣ Is the fixed income really fixed?
No, unless we keep the investment to maturity. It must be clear that it is called fixed income because the term of the investment is fixed, that is, the asset has a life with an expiration date or maturity in which the invested is returned. But the price of the asset fluctuates, so if you want to sell it before that maturity, you can incur losses if on that date its value is lower than when you bought it.
Fixed income is debt of companies or governments, and it does not make us shareholders, but creditors of the same. This issued and chopped debt is called Bonds. These bonds can be discounted or zero coupon, or payment by coupons. The most common is the second, for which we would periodically be paid interest or coupons for the investment, and at the end of the life of the bond would not return what was invested at the beginning. Keep in mind that the most common Bonds are usually 2, 5 or 10 years and even longer term.
In addition, bonds have quantitative variables such as Convexity or Duration (not maturity date), which allow us to know the risk associated with the asset.
In short, fixed income is a very good option if we are clear that it does not guarantee our investment unless we keep it to maturity, and they are usually long terms.
3️⃣ What do leveraged products offer?
Leveraged products are those that replicate an asset, i.e. they mimic an index, commodity or currency (underlying), and require less capital input than would be required if you were to buy the asset directly. These products have a very high associated risk, perhaps the highest risk, since, if they are sold to us as products with a higher return potential than buying the underlying directly, and it is true, they also assume potential losses much greater than the one that the underlying assets may have.
Some examples of leveraged products are CFDs or contracts for differences, FOREX or currency futures, credit purchases and options. All of them allow the investor to maintain an open position larger than the capital contribution.
In conclusion, these products require constant monitoring of the position, have complex quantitative characteristics and can generate losses greater than the capital invested.
4️⃣ Real estate investment: for our children
The investment par excellence of many citizens. It is estimated that around 30 percent of the disposable income of families is dedicated to investment in habitual residence. There are opinions on the matter that indicate that this is not an investment per se, but that it is an expense, since the asset does not generate profitability in itself since it is a habitual residence. Although it would generate a revaluation of the asset, it would not be available for sale unless we dedicate the same capital obtained by the sale to another real estate asset. Somewhere you have to live.
Following this argument, we would value the investment in brick as the purchase of a house, local or parking space, in order to be rented by third parties and obtain a periodic return, the rent. Making a parallelism with the variable income, the flat would be transformed in some way with shares of a company, where the value of the flat fluctuates according to the market, a periodic return is obtained as the dividends of the shares, also according to the market environment, and with some associated expenses in maintenance of the asset, that in the case of the shares would be the account of values, and in the case of the buildings, the expenses that we already know.
However, this market has a great handicap: the price. Real estate investment requires large volumes of capital even when resorting to banking resources. Only investors with a very solvent liquid capital accumulation can enter this market. In addition, it would drain a lot of diversification capacity in the other investment alternatives.
5️⃣ Nuevas ventanas para la diversificación: el Crowdfunding
After the last financial crisis, we are living new paradigms and new ways of approaching aspects of our daily lives, but also of investments. Many economic agents had to resort to alternative financing in order to carry out their business projects. In fact, during the Spanish bank rescue, a Memorandum of Understanding (MoU) was signed whereby the Spanish government undertook with the European Union to promote non-bank financial intermediation. It is important to note that many projects, even today, cannot access bank credit due to the requirements demanded by their risk departments.
Crowdfunding, or also called microfinance, has allowed many companies to finance themselves under very good conditions, creating new jobs and modern business structures. According to the magazine Emprendedores, companies such as Cebiotex, Glassy or Indi Marketers, among many others, are success stories that have managed to develop their revolutionary businesses in a far from easy environment, thanks to crowdfunding.
But also, this type of alternative financing has made it easier for many investors to invest where previously only large investors could. Through crowdfunding platforms, people with modest savings can participate in innovative projects for little money.
A very paradigmatic case is that of real estate investment. This sector has always been very attractive in any society, but traditionally more so in Spain, but at the same time, as we mentioned in the previous section, the most difficult because of the amount of money available that we must have to buy a house or a local. However, crowdfunding allows us to access the purchase of an apartment for later rental or sale after the corresponding reform, with very little money. We will be shareholders of a flat in the most coveted areas of the main capitals of our country and Europe.
How crowdfunding works. Well, a company, in this case a real estate developer, is looking for financing to buy a 300 square metre flat in the Paseo de la Castellana in Madrid and for this, contacts a crowdfunding platform. This is in charge of assessing the solvency of the developer and the viability of the project. Once the project is given the green light, it is the financing platform that announces to potential investors what type of project exists, what it is like, and what guaranteed profitability it offers. When, through this platform, we buy a share, for example 1000 euros, we are already co-owners of that flat in Castellana, and we have all the rights to receive the aliquot part of that rent. Something we would never have imagined before with so little money in a similar asset.