How to Classify an Investment

We are committed to a coherent and sound investment policy. Our intention is that it will dominate all the strands of the construction of an investment process, so in this article we will start with the base and show you how to classify all investments.

We are of the opinion that all variables and phenomena can be characterized and classified based on some common characteristics. In the case of financial assets, we highlight three characteristics that, when defined correctly, will allow to mark and distinguish all asset classes: we will speak next of expected return, risk and liquidity.

Expected Return

All investors in financial markets, even if they deny it, are speculators. That is, they are individuals who invest today in the hope of achieving a positive profit in the future, with the sale of the investment. Thus, those who choose an investment have an expectation of return, which goes hand in hand with the Risk / Volatility of the investment. As we will see, to get more return, we will have to assume a higher level of risk. Learn how to get started in the investment world here.

Risk

Risk

Another key variable when we talk about investments, which despite being an intuitive concept, we know the painful relationship that the Portuguese have with this variable, which is reflected in the very conservative positions that exist in relation to investments.

In fact, the definition of risk is quite simple and enlightening. Risk is the uncertainty inherent in an event, not having to be something, in itself, negative. It is simply something whose outcome we do not know precisely.

Never Forget the Relationship Between Risk and Return on Investments

Never Forget the Relationship Between Risk and Return on Investments

As we know, in the investment world there is a great relationship between risk and return. It seems logical, but this relationship is often overlooked by most investors. In fact, what is logical is that investors demand at certain level of return for an investment and that the higher the risk the greater the return.

This ratio is sufficient to describe the investors, characterized by risk averse. That is, between two investments with the same risk, we must choose the one with the highest expected return. In other words, between two investments with the same level of expected return, we should choose the one with the lowest risk.

Liquidity

The third concept we introduce is the concept of liquidity, which is nothing more than the possibility of buying or selling a particular asset, at a desired moment and at a price considered by the fair market.

An example is an action that has more liquidity than a real estate, because to make it into money just give an order to the broker. In the case of the property, we will have to wait a lot longer and the negotiation process is known to have lead to the decrease of the value that we obtain in the sale.

Time deposits are sometimes considered to be of immediate liquidity. However, due to the existence of penalties for early mobilization, the loss of the right to interest stands out, a factor that, in our view, limits this liquidity somewhat. Other products that create barriers to liquidity are investment funds, which can either stipulate minimum periods of stay or penalty conditions in the constitution as well as in redemption or demobilization.

Naturally, some products, because of their characteristics, may justify certain conditions. However, you will have to be careful about underwriting or redemption fees, which may seriously jeopardize the return on an investment. In this context, finally, we point out that the management companies do not habitually charge these commissions (which we consider to be somewhat abusive), despite having a lower tax efficiency.