Figure 8. Investment Resources and Assets
Stocks, Bonds, Mutual Funds,
Private Equities, Hedge Funds,
Real Estate, Metals, Energy,
Agriculture, and so on.
In the investment market, investors’ resource is capital.
The previous section explained the kinds of investment assets. Figure 8 has summarized all of them in investment resources and assets. Once capital is prepared, you can invest it in the asset that is expected to provide the safest and highest future value according to your own calculation or experts’ recommendation.
In the front section, to explain the optimal selection, it was assumed that each asset yields a 10 percent, 20 percent, or 90 percent return annually, and they are all safe. In the capital market, however, this is unrealistic. In the real market, the higher the investment return, the higher the investment risk. Several among the assets of figure 8 will be selected to verify it, and the return on investment provided by each asset in the real market will be compared. For the fair comparison, it will assume that the investment period is five years for all assets.
First, let’s look at bonds, which are considered a safe asset in the capital market. Among bonds, the safest one is the government bond that is issued by governments. According to Bloomberg, the yield of the US five-year Treasury bond is 1.84 percent as of the end of June 2017. If you invest $1,000 in it, the expected future value will be $1,100 after five years. Investment experts consider US Treasury bonds the safest asset in the world. Safe means ensuring the invested principal as well as the interests of it. The UK Treasury bonds provide a yield of 0.57 percent for the same period, German 0.28 percent, Japanese -0.09 percent, and Australian 2.07 percent. Negative returns might be unfamiliar, which means current investing $1,000 is guaranteed at less than $1,000 after five years.
Let’s take a look at stocks. Estimating the prereturn of stocks is difficult. They are different from bonds. Thus, the postreturn in the past five years will be shown by using the price index of stocks of each country. As of the end of June 2017, the Dow Jones Index, the key stock price index of the United States has gained the total return of 65.45 percent over the past five years, the yield of 13 percent per annum. It means you have $1,650 now if you invested $1,000 five years ago. The KOSPI index, the representative price index of the Korean stocks, has yielded 7.9 percent per annum over the past five years. The UK stocks have provided 6.6 percent, German 19.25 percent, Japanese 24.7 percent, and Chinese 9.6 percent. As a result, stocks have given higher returns than bonds. However, stocks are riskier than bonds because the volatility of their daily prices is severe like a roller coaster.
Oil and gold are also a good means of investment, and are classified as commodities. In the case of petroleum, it is difficult for the public to invest, but the transaction volume is considerable, and its influence on the market is massive. In general, when we talk about the oil price in finance, WTI (West Texas Intermediate) is most commonly used. WTI was $85 per barrel five years ago, but the price has dropped to $44 at the end of June 2017. Compared to five years ago, it has fallen by 48 percent, showing the yield of -9.6 percent per annum. The gold price was $1,604 per ounce five years ago, but it has recently dropped to $1,253. It has given the yield of -4.4 percent per annum over the past five years.
Japanese stocks have provided the highest investment return among all the assets explained so far, which has yielded the return of 24.7 percent per year over the past five years. If all the assets provide the same returns as the past in the future, you would surely invest in Japanese stocks. In this case, when you invest $1,000 there, you can expect a future value of $1,250 after one year, $2,240 after five years, and around $3,500 after ten years.
Can you imagine what will happen if the government of Japan announces that they will guarantee the return of 24.7 percent of Japanese stocks per annum over the next ten years when you invest in them?
A country typically guarantees its government bonds. However, what if Japan guarantees Japanese stocks to let you gain its annual return of 24.7 percent over the next ten years? It is a total return of 247 percent for ten years. Would you invest only a thousand dollars? You would never do so. You would sit in front of your desk and take out all your bank accounts, and you would calculate the total amount of money you can invest for the next ten years. Is that all? No! You would go to a bank and check the amount of a possible loan for ten years. So finally, if you invest $10,000 for ten years, you can expect $35,000 ten years later, $350,000 for $100,000, $3.5 million for $1 million, $35 million for $10 million, and $350 million for $100 million. The only thing you must do is endure the desire to use your money now for the next ten years.
Figure 9. Risk of Investment Assets
Unfortunately, however, no government guarantees the investment return of its stocks or other assets except its government bonds. Also, even if the asset has yielded a return of 24.7 percent over the past five years, it does not guarantee the same return in the future. Most people know that stocks are riskier than bank savings or bonds.
Figure 9 shows the risk degrees of two assets are different. The solid line is like a roller coaster, which shows that its profit could be high but its loss also substantial. Compared to that, the dotted line is gentler, indicating its profit is not high, but the loss is also not massive. Thus, the solid line represents a riskier asset than the dotted line. The stock corresponds to the solid line in figure 9. In the case of Japanese stocks, the average return over the past five years was 24.7 percent. However, it has also shown the negative return, –21.6 percent, from August 2015 to August 2016 like a roller coaster. You can get high profits by investing in them, but you can also lose big.
Figure 10. Relationship between Return and Risk of Investment Assets
The real capital market has the feature that the larger the expected return, the higher the risk.
Figure 10 shows that investment return and risk are in a proportional relationship. In the case of savings or bonds with high credit ratings, the expected returns are low, but they are unlikely to lose the principal. On the contrary, stocks may have potential high profits, but they are more likely to suffer losses. No investment asset offers a high return with no investment risk in the capital market. That is why many investment professionals are constantly studying, researching, and analyzing to find the assets with a higher return at the same level of the risk or with a lower risk at the same level of the return.
In some ways, the relationship between returns and risks seems very fair in the economy of the earth that God has created. Depending on one’s propensity, those who pursue safety may earn a corresponding rate of return, and the others who are willing to take a risk may expect a high return or face a big loss. If all investments have the same risk, who would go to a bank and save their money, or who would buy a US Treasury bond? Everyone would be attracted to stocks or other assets with higher returns.