LOOKING TO INVEST? These are the 4 major asset classes
If you are a serious investor – and that doesn’t mean speculating on the forex markets or on the price of crypto or gold, but investing in something that will grow and reward you with compound returns over the long term – you can choose among four broad classes of investments, known as asset classes. They have different characteristics, each with its own advantages and disadvantages and each with a specific risk-reward profile: some are more risky than others in that you could lose money over the short term, but they reward you for taking on that risk by delivering better results in the long term. The asset classes are also not necessarily correlated with each other, which means that while one class may be performing well, another may be performing poorly.
Collective investments, such as unit trust funds and exchange traded funds, invest in a basket of assets. Some focus on a specific class, such as equities, while others, called multi-asset or “balanced" funds, diversify across asset classes.
Equities are shares in companies. You can own shares in a private company (private equity) or in a public company listed on a stock exchange (listed equity). As a shareholder, you are a part-owner of the company and therefore share in its profits, which are paid as dividends. You also have a say in how the company is run – you can attend and vote at the company’s annual general meeting. Unlike private equity, listed shares are bought and sold on the stock exchange, so their prices take on a life of their own. The share price is usually, but not always, indicative of how well the company is doing. Equities can be high-risk over the short term, but can deliver high returns over the long term.
Property investments take two forms:
1. Physical property. This is property you buy to let (a property you buy to live in yourself cannot be considered an investment in the context of this article). Buy-to-let property comes with expenses, such as bond repayments, rates, insurance and maintenance, but it also provides an income in the form of rental. Over time, the value of the property itself will also rise.
2. Listed property. This is an investment in a company that specialises in buying and managing property, typically large commercial properties. These companies take on the work of maintaining the buildings and finding tenants. They pay their shareholders dividends from the profits they make on rentals. So it’s very similar to investing in equities.
A bond is a type of debt, basically in the form of an IOU. Companies and governments issue these “IOUs” when they need cash. The bond is for a set capital amount (say, R1 million), which the bond issuer receives from the investor. The issuer then pays the investor a set interest rate on that amount for the period of the bond. When the bond matures (you get long-dated and short-dated bonds), the capital is repaid to the investor.
Bonds are traded on a secondary market, much like shares, and their prices go up or down depending on how the interest rate of the bond compares with prevailing bank interest rates.
Individual investors don’t normally invest directly in bonds, as the amounts required are large, so they invest in unit trust funds that focus on bonds. Investing in bonds is considered less risky than investing in property or equities, and while the returns are more stable, they don’t “shoot the lights out”, as equity investments sometimes do.
This is the safest of the asset classes, but it also delivers the lowest returns. Investing in cash is simply putting your money in a bank savings account or in a money market fund. You will be paid interest on the balance in your account, but it may not beat the inflation rate, so you may effectively lose money if you are invested in this way for too long. The more flexibility you have to deposit and withdraw money, the lower the rate, and vice versa. So a five-year fixed deposit will pay a higher interest rate than a 32-day notice account.
This article appears in the latest edition of IOL MONEY digital magazine, which focuses on "Investing on 2021". For free access to the magazine CLICK HERE!