What are financial instruments? A beginner's guide

When it comes to financial instruments, many people may feel that they are something distant. But in reality, they are the fundamental basis of modern investing. Whether you are a beginner or interested in learning about money management, understanding different types of financial instruments will open up a new world of income-generating opportunities.

What are financial instruments? Let’s understand them clearly

In the simplest terms, financial instruments are documents or contracts that represent rights and obligations regarding money between the buyer and the seller. The prices of these instruments are not fixed but fluctuate according to market conditions, economic situations, and supply and demand at different times.

Compared to buying stocks, when you hold shares of a company, it means you own a part of that company. When you decide to buy bonds, you are lending money to the issuer and receiving interest as a return.

Classifying financial instruments: simple and complex

Financial instruments can be divided into two main groups based on understanding and risk:

Simple instruments: Suitable for beginners because of their clear structure and easy understanding, such as stocks (Stocks), bonds (Bonds), fixed deposits (Fixed Deposits), and mutual funds (Mutual Funds).

Complex instruments: Require more knowledge and experience, such as derivatives (Derivatives), options (Options), futures (Futures), and convertible bonds (Convertible Bonds). These carry higher risks but can offer higher returns when used appropriately.

Types of financial instruments you should know

1. Equity Securities(

Stocks )Stocks(: When you buy stocks, you become a shareholder of the company, with rights to participate in major decisions and receive dividends. The main two types are common stocks )with voting rights( and preferred stocks )receive dividends first but without voting rights(.

Warrants )Warrants(: Give the holder the right to buy shares at a predetermined price within a specified period.

) 2. Debt Securities###

Bonds (Bonds): Debt instruments issued by governments or companies. Holders receive regular interest payments and get the principal back at maturity.

Corporate Bonds (Corporate Bonds): Bonds issued by private companies, suitable for those seeking steady income.

Bills (Bills): Short-term debt instruments, generally not exceeding 1 year.

( 3. Derivatives)

Futures ###Futures(: Contracts that obligate the purchase or sale of an asset at a future date at an agreed-upon price. Commonly used for commodities like oil and gold.

Options )Options(: Contracts that give the right )not mandatory( to buy or sell an asset in the future.

Swaps )Swaps(: Agreements to exchange cash flows in the future between two parties.

) 4. Other Popular Instruments(

Mutual Funds )Mutual Funds###: Pool money from many investors to invest in various securities, helping diversify risk.

ETFs (Exchange Traded Funds): Funds traded on stock exchanges that track indices or asset groups.

REITs (Real Estate Investment Trusts): Companies investing in real estate, paying dividends to investors.

Caution for beginners: don’t let risks bite you

Before investing, beginners should understand some important points:

Don’t skip education: Not knowing about the securities you invest in = poor decision-making. Learn about each instrument, factors affecting prices, and how to analyze fundamental data.

Start small to learn: Don’t invest large amounts initially. Choose an amount you can accept losing without affecting your daily life.

Be cautious with leverage (Leverage): Borrowing money to amplify investment returns is risky. It increases profit potential but also the chance of greater losses. Use low leverage to protect yourself.

Diversify risk: Don’t invest all your money in a single type of instrument. A diversified portfolio will suffer less when the market declines.

Comparison table of major financial instruments

Pros and cons: financial instruments have both sides

Advantages:

• Diversity: Choose instruments aligned with your goals and risk appetite.
• High liquidity: Easy to buy and sell, quickly convert to cash.
• Risk spreading: Avoid putting all funds into one instrument.
• Steady income: Bonds / Fixed deposits provide consistent returns.

Limitations:

• Market volatility risk: Stocks can lose value.
• Complexity: Some instruments require additional knowledge.
• Default risk: Companies may fail to pay.
• Fees and expenses: Reduce your actual returns.

How to choose the right financial instruments

( 1. Set clear goals

• Need steady income? Choose bonds or fixed deposits.
• Want long-term capital growth? Stocks might be a good option.
• Want risk protection? Derivatives like options can help.

) 2. Assess your risk tolerance

• Low risk: Fixed deposits / government bonds.
• Moderate risk: Corporate bonds / mutual funds.
• High risk: Stocks / derivatives.

3. Consider investment horizon

• Short-term: Treasury bills / short-term bonds ###high liquidity###.
• Medium to long-term: Stocks / long-term bonds (higher returns).

Popular trading instruments

For those interested in short-term trading (buying and selling), popular financial instruments include:

Stocks: Traded on stock exchanges, with opportunities for profit from price changes. Suitable for those who study companies thoroughly.

Forex: Currency trading, open 24 hours, high liquidity. Suitable for technical analysts. Popular currency pairs include USD/JPY, EUR/USD, USD/THB.

Futures: Trade commodities like oil and gold, helping manage risk.

CFD (Contract for Difference): A popular derivative that allows trading based on price movements without owning the actual asset. Can use high leverage, trade both upward and downward, suitable for speculation.

ETFs: Funds traded on stock markets, easy to diversify, low trading costs. Suitable for those seeking stability.

Summary: financial instruments open the door to the world of investing

Financial instruments play a vital role in wealth creation and money management, whether stocks, bonds, derivatives, or others. Each type has its unique features and potential.

Understanding financial instruments is crucial to knowing which tools suit your goals. Study thoroughly before investing, start with small amounts, and remember that “good investing is investing that you truly understand.” With careful selection and good planning, you can build a diversified and successful investment portfolio.