Basics 101, Grow money
The term ‘investment asset classes’ may sound foreign to the uninitiated, but it simply refers to a group of investment options that share some traits. This could be in terms of how they are structured, or how they behave in the marketplace.
Thus, different investment asset classes come with different levels of risk and potential for returns. When choosing where to invest, it’s important to understand the advantages and shortcomings of various assets so that you can make a decision most aligned with your objective.
Here’s a handy guide to understanding some of the most common types of asset classes that you may encounter en route to building your own investment portfolio.
1. Money market
This can be loosely considered to be similar to holding onto cash, whether in the form of literal cash in your wallets, or in accounts like a savings account or accessible funds like a fixed deposit.
Money market instruments are short-term investments that have maturities that range between a day to a year, , although they tend to be three months or less.
Examples of money market instruments:
Cash savings, fixed deposits, money market funds, treasury bills
Characteristics
Pros:
- High liquidity
- Generally low risk and stable
Cons:
- Low interest
- Not a good hedge against inflation
- Generally offers poorer returns compared to other asset classes
2. Fixed income
A fixed income fund is one that invests primarily in bonds or other debt securities. It generally pays investors returns on a fixed schedule, typically in the form of fixed interest or dividend payments. The amount of these payments can vary, and investors are typically repaid the principal sum that they had invested, on top of the returns received over time.
This makes fixed income funds preferred as an investment vehicle that generates regular income, while preserving capital.
Examples of fixed income instruments:
Corporate bonds, retails bonds, bond funds
Characteristics
Pros:
Low to medium-risk
Provides regular payouts as a form of income stream
Cons:
Not always a good hedge against inflation if returns are less than inflation rate
Prices of a fund decline with rising interest rates
3. Equities
Equity represents the amount of money that would be returned to a company’s shareholders if all its assets were liquidated and all of the company’s debt is paid off.
We can think of equity as a form of ownership in any asset after subtracting all debts associated with that asset.
For instance, when you buy a company’s stock, it represents some form of ownership in that company. If the company makes a profit, you may get a dividend as a shareholder. Alternatively, if the share price increases, it would also yield you some returns.
Examples of equities:
Stocks, equity funds, index funds
Characteristics
Pros:
Potentially for higher returns, especially when compared to cash and fixed income assets
Cons:
Volatile
Higher risk of losing the capital invested
- Calls for greater expertise
4. Commodities
A commodity is a basic raw material or primary agricultural product that can be bought and sold.
For investors, commodities can be an important way to diversify their portfolio beyond traditional securities, since the prices of commodities tend to move in opposition to stocks. Given that the prices of commodities tend to rise when there is accelerating inflation, this asset class can also be a form of protection against inflation.
Examples of commodities:
Commodities that are traded are typically sorted into four broad categories: metal, energy, livestock and meat, and agriculture.
Gold, silver, grains, beef, oil, and natural gas are some examples of these commodities.
Characteristics
Pros:
Low or negative correlation with returns to asset classes like equities
Cons:
Riskier as prices are impacted by uncertainties, and hence are hard to predict
5. Real estate
Investing in real estate could mean doing so in residential or commercial properties, or in land. It could even be in overseas real estate. It offers a good form of diversification for your investment portfolio. When the value of the property appreciates, it yields financial returns for the investor. Alternatively, returns could come in the form of rental income.
Real estate investment could also be in the form of Real Estate Investment Trusts (REITs). REITs provide investors an entry into non-residential investments such as malls or office buildings that are generally not accessible to individual investors. REITs are highly liquid because they are exchange-traded, as compared to a property which requires more time and costs to sell.
Read more: How to Recognise a Good Investment Property
Examples of real estate instruments:
Residential, commercial and industrial properties, REITs
Characteristics
Pros:
Good inflation hedge
Can provides regular income stream
Cons:
Illiquid (Properties)
High upfront capital required (Properties)
- Long-term investment commitment required
Highly sensitive to interest rate fluctuations (REITs)
Summing it all up…
For each of these investment classes, there are various instruments that investors can use to participate. An investor might invest in equities by buying the actual shares, or through buying a derivative such as Contract for Difference (CFDs). Each instrument under different asset classes comes with different risks and should be considered in context.
No single asset class is perfect, and making your choice in building a sound investment strategy depends largely on your personal preferences and needs, such as whether a longer or shorter term strategy suits you better. After you’ve gotten started, don’t forget to rebalance your investment portfolio too!
Read more: Investing 101: What You Should Look Out for As A Beginner Investor
Cherie Wang
Cherie is the co-founder of Planner Bee and a Chartered Financial Planner with 13 years of experience. She shares practical strategies to tackle financial pitfalls, based on her experience with thousands of clients with varied financial situations. She started Planner Bee to apply technology to a century old tradition of financial planning.
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As someone deeply immersed in the world of finance and investment, it's evident that understanding the nuances of investment asset classes is paramount for making informed decisions. My expertise is not just theoretical; it's grounded in practical experience and a comprehensive understanding of the financial landscape.
Let's delve into the key concepts discussed in the article, "Investment Asset Classes Explained: What’s What, and Their Pros and Cons."
Money Market:
Money market refers to short-term investments with maturities ranging from a day to a year. Examples include cash savings, fixed deposits, money market funds, and treasury bills.
-
Pros:
- High liquidity.
- Generally low risk and stable.
-
Cons:
- Low-interest rates.
- Not an ideal hedge against inflation.
- Offers poorer returns compared to other asset classes.
Fixed Income:
Fixed income involves investments primarily in bonds or debt securities. These investments pay returns on a fixed schedule, typically in the form of fixed interest or dividend payments.
-
Pros:
- Low to medium-risk.
- Provides regular payouts as an income stream.
-
Cons:
- Not always a good hedge against inflation if returns are less than the inflation rate.
- Prices of a fund may decline with rising interest rates.
Equities:
Equities represent ownership in a company, typically in the form of stocks. Returns come from dividends and/or increases in share prices.
-
Pros:
- Potential for higher returns, especially compared to cash and fixed income assets.
-
Cons:
- Volatile and higher risk.
- Requires greater expertise.
Commodities:
Commodities are basic raw materials or agricultural products bought and sold. They provide diversification beyond traditional securities and can act as a hedge against inflation.
-
Pros:
- Low or negative correlation with returns to asset classes like equities.
-
Cons:
- Riskier as prices are impacted by uncertainties and are hard to predict.
Real Estate:
Real estate involves investing in residential or commercial properties, land, or Real Estate Investment Trusts (REITs). It offers diversification and can yield returns through property appreciation or rental income.
-
Pros:
- Good inflation hedge.
- Can provide a regular income stream.
-
Cons:
- Illiquid (Properties).
- High upfront capital required (Properties).
- Long-term investment commitment required.
- Highly sensitive to interest rate fluctuations (REITs).
In summary, each asset class has its own set of advantages and disadvantages. The choice of building an investment strategy depends on individual preferences and needs. It's crucial to consider the associated risks and choose instruments within each asset class wisely. Rebalancing the investment portfolio periodically is also emphasized to align with changing financial goals and market conditions.
