Change the Way You Invest by Understanding Asset Classes.
If you have an understanding of the different asset classes, it will help to change the way that you invest!
Now that we have had an in-depth look at what the stock market is all about, we can move onto Unit Trusts as the next topic or investment vehicle (investment option). Before I do this we need to rewind one step quickly and talk about something that is called ASSET CLASSES. The reason, for this, is because without this foundation information, we will not understand how most investment options are structured.
I encourage you to come to grips with the term ASSET CLASSES and ASSET ALLOCATION, as this will play a major role in setting up a successful investment portfolio for yourself.
Before we can really go in depth for selecting the right funds for your portfolio, we need to understand how those funds are put together and what different asset classes are available to add to the funds and how they impact the fund selection. So what I am going to be doing in this article is elaborate on the four main kinds of asset classes that can be used to construct a fund and how these asset classes can affect the risk factor of the fund.
THE FOUR MAIN ASSEST CLASSES
The first asset class that we have already touched on in detail in my last post (investment 101: Stocks) is stocks, shares or EQUITY.
Equity is an asset class which represents listed shares or stocks in listed companies on the stock exchange, or JSE as we know it in South Africa. How INVESTORS make money from Equity’s is from the share price that can go up (or down) and dividends that companies pay out if they make a profit. If you missed the last article, I would encourage you to go back and read through it as it will give you more insight into equity and stocks.
The second ASSET CLASS that I want to touch on is BONDS.
Bonds work exactly the same as a bond that we are used to on the property that we buy. Basically bonds are debt instruments, where the government, municipalities, and corporates, borrow money from investors for a predetermined length of time and with a predetermined interest rate.
The investment return that an investor gets on bonds is dependent on the riskiness of the borrower. The lower the credit rating (or higher risk) of the borrower the higher the interest rate on the bond will be.
The third ASSET CLASS I want to mention is PROPERTY or REAL ESTATE.
Property is probably the most well know asset class amongst all of us. In a nutshell property is physical property (bricks and water) and is mostly commercial property.
How investors make their money out of property is through rental income, and hopefully an increase in the actual value of the property over the time of owning the property.
Last but not least, the last asset class I want to touch on is CASH or often known as THE MONEY MARKET.
Cash has high liquidity (easily accessible) and is only really used if you want to invest for a very short period, as it doesn’t give you a very big return.
Basically with cash you are lending your money to the bank, and they give you a certain interest rate that is a little higher than a normal bank account so that they can take the money and invest it for themselves or lend it out at a higher interest rate.
ASSET CLASSES CAN ALSO BE SPLIT BETWEEN OFFSHORE & LOCAL INVESTMENTS.
These four asset classes that I have touched on above are available both domestically (locally) and internationally (offshore). While the characteristics of each class remain the same regardless of the country that it is invested in, purchasing assets internationally means that they may also be impacted by any change in exchange rates. You also get diversification by investing into other markets and not just in your own countries market.
WHY ARE ASSET CLASSES SO IMPORTANT???
You are probably wondering why on earth did I bore you with this information of different asset classes.
The answer to that question is easy, it’s all about risk and reward. Risk is something we can’t escape from when it comes to investing, however it is something that we can try to control and understand.
In order for one to get a good return on your investment you must take some risk, and the better you understand risk, the better your decisions will be when facing it.
Understanding how much risk your personality is willing to take determines hugely on how you set up your investment portfolio with the above ASSET CLASSES. Remember that the higher the risk, the higher the possible return, but also the possible loss.
Risk of Each ASSET CLASS:
If we look at the above four asset classes in general,
- cash would be your low risk investment,
- then BONDS,
- then PROPERTY and
- EQUITY would then be your higher risk investment.
So your investment goals will determine how you need to structure your portfolio, we call that asset allocation.
In layman’s terms that means, what percentage of each asset class you need in your portfolio to achieve your investment goal or take on the amount of risk that you are prepared to take on as an investor.
You can have funds that have a single asset class for example an EQUITY FUND, or you can have funds that have a split ASSET ALLOCATION OF THE FOUR MAIN ASSET CLASSES.
ONCE YOU HAVE THE BASICS OF ASSET CLASSES AND ASSET ALLOCATION UNDER YOUR BELT, YOU WILL BE IN A WHOLE NEW CLASS WHEN IT COMES TO INVESTING.
August 18, 2014
Grant van Zyl