UNDERSTANDING ASSET CLASSES

Understanding asset classes

When building an investment portfolio, it's important to understand the differences between the main asset classes, and how they may be able to help you achieve your financial goals.

You can choose from a wide variety of investments, offering different levels of risk and return, with investments that behave in a similar fashion being grouped together as an ‘asset class’. Each asset class can also be further sub-categorised, for example by geography or sector.

Investing a portfolio across multiple asset classes can help smooth fluctuations in value, with many investors choosing to diversify across multiple asset classes. An explanation of the key asset classes is found below.

Bonds

Bonds are a form of tradable loan that can be bought and sold on the secondary market. The terms of the bond - including interest payments - are defined at outset and generally provide a predictable income stream for the bond holder.

Bonds are often favoured by investors who are looking for a regular income stream and are generally considered to be a more secure and predictable investment when compared with equities. This is in part because bonds take priority over equities in a company’s capital structure, and so would be repaid first in the event of bankruptcy.

Equities

Equities - also called stocks or shares - provide their holder with an ownership stake in a company. The market's perception of the company's value is reflected in the price of their shares on the stock market, and you can earn a return from equity investments in two ways:

Property

Property encompasses both 'bricks and mortar' physical property and investment in Real Estate Investment Trusts (REITs), which invest in both residential and commercial real estate on their share holders' behalves.

Returns from property investments are earned through:

Like other asset classes, property can be further categorised in to sub-classes. While many investors can easily gain access to residential property - often through purchasing their own homes - it is more difficult to access commercial property without investing through a REIT or managed fund.

Alternatives

Alternatives fall outside of the traditional asset classes explained above, and their lower correlation to financial markets can provide valuable opportunities for portfolio diversification.

Due to their unconventional nature, alternatives are often more difficult to value and less liquid than traditional asset classes. Examples of alternative assets include commodities, infrastructure and hedge funds.

Cash

Most investors choose to keep a portion of their assets in cash. The value of cash can be eroded if the interest rate earned on the account is lower than the inflation rate; this is why many investors hold cash to service their short-term commitments, and invest to strategically grow their wealth.

Important information:

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