Asset classes are an important concept in investments which is used to categorise different types of investments. We’ve pooled together all the info you need to know about them so you can get started on growing your money.
What are asset classes?
Asset classes are categories of investments, and these categories contain specific assets which are expected to share three common characteristics:
- have similar risks and returns,
- be subject to the same general legal framework, and
- perform similarly in particular market conditions.
What are the different types of asset classes?
There are four main asset categories: cash, fixed interest, property and shares. Each has a unique combination of characteristics, risk levels and potential return.
Low risk defensive investment.
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 this asset class is in not being able to match inflation i.e. the purchasing power of your asset declines because the return on the asset is lower than the inflation rate. A cash asset can take the form of something like a short-term bank deposit, which doesn’t generally offer any potential for capital growth.
Low-to-medium risk defensive investment.
Fixed interest assets are slightly more volatile (i.e. carry more risk) than cash assets, but not volatile enough to be categorised 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 much risk and the return potential is typically higher than what you would receive from investing in a cash asset.
Medium-to-high risk growth investment.
Property investments include both physical property and listed Real Estate Investment Trust (REIT) investments (REITs are pooled property investments that have been separated into units and are now listed on the stock exchange so investors can have 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 centres etc. REIT prices not only fluctuate according to property fundamentals, but with share market volatility as well.
High risk growth investment.
Owning a stock or a share means owning a slice of a publicly listed company. The value of shares fluctuate with general economic, industry and market conditions.
Share prices will also fluctuate with changes in company profitability, changes in investor sentiment, evolving consumer tastes and a whole host of other unpredictable factors. For these reasons shares are viewed as riskier than cash, fixed interest and property as investment assets.
How are asset classes categorised?
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, such as cash and fixed interest assets, are designed to grow your income while providing a measure of protection 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 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 peaks and troughs of the market over time.
What is diversification & why is it important?
Diversification is a way of managing risk, and it involves spreading your investments over different asset classes to hopefully generate more consistent returns. Having a diversified portfolio means that when one asset class is under-performing, it may be offset by a more positive performance from one or more other asset classes.
Which asset class is best for me?
Each individual investor may be best suited to a different blend of asset classes that, when combined, reflect their investment goals and risk profile.
This risk profile should take into account your attitude towards volatility and ideal investment term. These are all things that are factored into tailoring your own unique Clover investment portfolio, where we’ll help you set a savings goal, determine your risk tolerance and recommend an investment timeframe.
The table below details each asset class and their respective risk level and expected return, as well as examples of each.
|Asset Class||Examples||Risk||Potential Return|
(focus on generating income)
|Cash||Bank deposits, term deposits, cheque & savings accounts, & cash management trusts||Low||Low|
|Fixed Interest||Government bonds, corporate bonds, mortgages & hybrid securities||Low/Moderate||Moderate|
(focus on capital growth & income)
|Property||Investments in industrial, commercial & residential property||Moderate/High||Moderate/High|
|Shares||Australian & International equities||High||High|
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Also published on Medium.