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Investing 101: #4 Asset Classes Explained
If investing is something that’s likely to feature in your financial future, understanding the difference between asset classes is an important first step.
What are the main asset classes?
There are lots of asset classes, but the following six are regarded as the most customary:
- Equities (Shares)
Remember: An asset class is a group of investments that look and behave similarly.
Asset class overview
Cash is held in a bank account where interest is likely to be gained, like on-demand savings, current and term deposit accounts, cash Individual Savings Account (ISAs) and premium bonds.
- On-demand & current accounts: On-demand accounts usually mean money can be deposited for as long as you like and offer instant access, if you need to withdraw funds. The flexibility comes at a price however and they tend to offer very low interest rates, if at all.
- Term deposits: Term deposits offer a sliding scale of interest based on how long you’re comfortable committing your money, without access. Terms range from months to years and some short-term deposits provide limited access in the case of an unplanned event.
Deposit accounts are a popular choice for investors who want to keep a portion of their assets in a lower-risk asset class. It can help with diversification, but with interest rates at an all-time low and inflation eroding the cash value, fund managers are careful to ensure it’s not over-represented as part of any portfolio.
Remember: Cash is low-risk and offers instant access, but inflation can threaten value.
Bonds, also known as Gilts and fixed income securities, are issued by companies and governments as a way to raise capital. They’re IOUs effectively and promise to pay back the loan, with interest, at a set date in the future.
They also provide an annual return or coupon as a loyalty reward to incentivise bond holders.
Once issued, they can be bought and sold openly without the issuer being involved and their popularity and price will rise and fall in line with how the company performs. The better the company is doing, the more attractive the bond.
Since much of a bond’s return relies on the interest rate, the value can fluctuate as market interest rates change.
No asset class is risk-free, but bonds are generally considered to be lower-risk investments.
Remember: Bonds provide lower-risk annual return and potential capital growth.
Equities (or Shares)
Equities are issued by public limited companies and traded on the stock market. Investors buy shares in these companies and become shareholders. Once invested, they can potentially generate profit in two ways:
- Capital growth, as a result of rising share prices, or
- Income from dividends
Both are possible, but neither is guaranteed as there’s no perfect time to buy. Fund Managers make educated decisions, making ‘time invested’ more important than ‘timing’, as no one can predict a rise or fall with 100% certainty.
From a risk perspective, equities are considered medium-to-high risk, but it’s possible to reduce risk by investing in shares across a range of business types, economies and sectors.
Remember: Equities sit at the higher end of the risk scale, but offer investors the opportunity to become shareholders in a range of companies, economies and sectors.
Property can be an appealing choice for investors as some people like the idea of buying something tangible, like bricks and mortar, in a bid to diversify their portfolio risk.
Remember: Property offers the prospect of capital growth and a rental income stream, however, performance is completely dependent on the market and you may have additional expenses in the form of maintenance.
The recovery of the global economy has created new interest in the commercial property sector.
It’s attractive for two reasons: rent and property value, both of which can prove very lucrative. Companies looking for new or bigger premises can generate long-term rental income and if you can charge more than you paid, you’re making money on your investment. Commercial property is sensitive to economic factors, however, and if there is a recession, demand for commercial premises usually falls meaning you could stand to lose value on your investment.
Similarly, if demand is greater than supply, property values rise and can be sold at a profit to make a capital gain.
Remember:Commercial property focuses on driving profit through rental income and increased property value performance but will depend on supply and demand in the economy.
Commodities are tradable items like oil, gas, copper, gold and wheat. They’re usually produced by a multitude of suppliers and the price can fluctuate along with supply and demand.
Remember:Commodities can be complex, expensive and risky, but can present opportunities when other more traditional assets aren’t performing.
As an asset class, it’s considered a more specialised area of investment and can perform at times when more traditional assets do not, making them an interesting diversification option.
Alternatives is a broad term for investing in a non-traditional way.
It looks at being alternative in terms of what you invest in and how you invest. For example, it can mean an alternative twist on a more traditional asset, like Emerging Market Equities.
Or a non-traditional strategy that aims to generate positive returns in rising and falling markets, like Target/absolute return funds.
In terms of diversification, alternatives try to protect against inflation and bolster portfolios against traditional market downturns which can be higher risk.
Remember:Alternatives can offer investors something more specialised and an opportunity to profit when traditional markets are not, however, they tend to be more volatile than traditional investment vehicles.