A Quick Guide to Asset Classes
January 6, 2021 | Joyce Ibrahim
Too many young people miss out on the benefits of investing early because of their lack of understanding of how the world of investments functions, a mistake that could cost them millions. But knowledge is more accessible today than ever, and with the right information, young investors can make more enlightened decisions and grow their wealth with more confidence.
Asset classes are the most basic but also the most important concept in investments, and those who take the time to understand these simple principles and the different asset classes will reap the benefits in the long term.
To demystify what it takes to start investing, we help you distinguish the different types of investments and how they rank on the risk ladder.
What are asset classes and how are they categorized?
Asset classes are types of investments that share common behavior and characteristics. When assets are grouped together under a class, they are expected to:
- Offer similar risks and returns
- Function under the same general legal framework
- Perform similarly in particular market conditions.
There are four main asset categories: cash, fixed interest, property and shares. Each offers a specific set of characteristics, risk levels and potential return.
Cash is the term used for highly liquid, short-term investments. This asset class offers the lowest potential return on investment. The main risk with cash is its inability to beat inflation. For example, the purchasing power from your cash asset could decline, because the return would be lower than the inflation rate. A cash asset can take the form of a short-term bank deposit, which doesn’t generally offer opportunities for capital growth.
- Fixed Interest
Fixed interest assets are more volatile than cash assets, and therefore carry more risk, but are not volatile enough to be categorized as ‘growth’ assets. An example of a fixed interest asset is a government or a corporate bond. A bond is issued when a government or a company borrows money and pays interest on the money borrowed (known as coupons) with the principal to be repaid on a fixed date.
These kinds of assets don’t carry significant risk and the return is typically higher than what you would receive from investing in cash.
Property investments include both physical property and Real Estate Investment Trust (REIT) investments. REITs are pooled property investments that are divided into units, and are listed on the stock exchange for investors to earn liquidity. These investments include both residential and commercial property.
Putting your money into REITs means investing in property such as industrial warehouses, hotels, office buildings and shopping centers etc. REIT prices not only fluctuate according to property fundamentals, but with share market volatility as well.
Owning a stock or a share means owning a slice of a publicly listed company. The value of shares fluctuates with general economic, industry and market conditions.
Share prices also fluctuate with changes in a company’s profitability, changes in investor sentiment, consumer preferences and other unpredictable factors. For these reasons shares are viewed as riskier than cash, fixed interest and property as investment assets.
These four asset classes are classified as either growth assets, which generally offer higher risk with higher return potential, or defensive assets, which typically offer lower risk with lower return potential.
- Defensive assets
Defensive assets, such as cash and fixed interest assets, help you increase your wealth while protecting you against large falls in your portfolio’s value. These are a popular option for investors looking for short-term or risk-averse alternative, as they’re safer, more secure investments which tend to provide a more consistent rate of return.
- Growth assets
Growth assets like property and shares, on the other hand, may generate higher returns over the longer term, but will be more volatile from week to week and month to month. Investors tend to go for this option if they have a long-term savings plan in mind and are looking for capital growth, but are also willing to ‘ride out’ the market.
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