A Beginner's Guide to Asset Classes

This blog post is here to provide a clear and concise guide to one of the fundamental elements of any investment strategy: asset classes. Asset classes are simply a group of investments that share similar characteristics and behave similarly in the market. By understanding the different asset classes and their historical performance, investors can make informed decisions about how to allocate their capital and build a diversified portfolio.  We will go over the four main asset classes and the pros and cons assosciated to each of the different asset classes. However, a mix of assets can help you create a balanced portfolio that reflects your risk profile. In this blog, we will go over the pros and cons for each different asset class along with the risks associated with them. 

Equities 

Equities, also known as stocks and shares, represent ownership in publicly traded companies. When a company performs well, its stock price will rise, offering investors returns on their investment. Equities are often traded on stock exchanges, such as the FTSE and NYSE, and are seen as high-risk high-reward assets. This is because stock prices often rely on several factors including the company’s forecast and investor demand and as such they are volatile. Historically, investors have seen returns, especially through the S&P500 (a stock index fund) which has delivered an average annual return of around 10.26%. Markets are often volatile in the short run but will even out in the long run, so you should invest for a minimum of five years, this will maximise your opportunity for the peaks and troughs to smooth out. Also, there is no guaranteed Income - Unlike bonds, which pay regular interest payments, stocks don't guarantee any income.  While some companies pay dividends, these are not guaranteed and can be cut or suspended at any time.

Overall, equities are a great tool to invest in, however, it is important to invest according to your risk tolerance and investment goals. Also, it is important to diversify your portfolio with other asset classes.

Fixed income securities

Fixed-income securities, also known as bonds, are essentially loans made to governments or companies. When you buy a bond, you are essentially lending money to the issuer in exchange for a fixed interest rate over a set period. Bonds are generally considered to be a lower-risk investment than stocks, as they offer a steady stream of income, you can also receive a larger lump sum once it matures. Government bonds are the most common type of bond that is offered to the public and varies by country - in the US, the public is offered  Treasury Bonds. They come in maturities ranging from one to thirty years. Treasury bonds are considered to be one of the safest investments in the world. In the UK, we have gilts. They also come in a variety of maturities. Gilts are considered to be a safe investment, but they are not quite as safe as Treasury bonds.

While often less risky than investing in stocks, you should still consider who is issuing the bond and whether they’re likely to default. There is still a risk that you could lose your money.

Cash and Cash equivalents

Cash is the asset most people are familiar with, as we use it in our day-to-day lives. This also includes savings accounts, money market accounts, and certificates of deposit (CDs). These investments offer a low rate of return but are highly liquid, meaning they can be easily converted into cash when needed. It is also important to note Thanks to the Financial Services Compensation Scheme (FSCS), so long as you save with a UK-authorised bank, your money is even protected if the financial firm fails. The FSCS could compensate up to £85,000 per person, per bank, building society, or credit union. The US equivalent of FSCS is the Federal Deposit Insurance Corporation (FDIC). As opposed to the FSCS's more limited £85,000 deposit guarantee, the FDIC guarantees up to $250,000  (approx £200,000). As a result of this, cash is seen as “safe” and is a good asset class to hold wealth if you need access to it, are building an emergency fund, or have short-term goals. However, there is one main problem with cash and that is inflation, meaning the value of cash may fall in real terms. This is significant as while you can earn interest on your cash, it is unlikely to match the rise in the cost of living and thus your purchasing power will fall. 

While cash is generally known as a safe asset, the decision whether to hold cash or not depends on your own investment goals - as it is subject to inflation, other asset classes are likely to be more beneficial in the long term. 

Real Estate

This asset class includes and, buildings, and other physical property. Investors can participate in real estate directly by purchasing property or indirectly through real estate investment trusts (REITs). In the UK, property prices have risen by over 65% in the last decade alone, and there are many different ways that real estate can be part of your financial plan. These include - Direct ownership & Real Estate Investment Groups. Direct ownership involves purchasing a property outright and assuming full responsibility for maintenance, repairs, and tenant management. It offers the potential for higher profits but also requires more effort and upfront capital, and at around £290,000 on average for a house in the UK, it may not be the choice for most. Real Estate Investment Groups are private investment groups that pool funds from multiple investors to purchase real estate.  REIGs can offer access to a wider range of properties and expertise than individual investors might have, but they often come with higher investment minimums and fees. 

Building a balanced portfolio doesn't necessarily mean buying a physical property yourself. Property funds open the door to the commercial real estate market, allowing you to invest globally in office buildings, warehouses, and more.  This can be a good option for those who want exposure to real estate but don't have the capital or desire for direct ownership. Real estate can offer the potential for capital appreciation and rental income, but it is also a less liquid investment than stocks or bonds.

Asset Diversification

Now that you have a basic understanding of asset classes - it is important to understand the importance of asset diversification. Asset diversification involves spreading your money across different types of investments to reduce overall risk. This means investing in equities along with fixed securities - for example, if the stock market crashes, your losses in equities may be offset by gains in bonds or real estate. Reducing risk should be a must for any investor and that’s why it is so crucial to diversify your assets.

Understanding all the main asset classes is a key step for any investor - making yourself familiar with each of these asset classes and how they behave in the market is key to being successful as an investor. In the next blog, I will go over the other 2 asset classes - Alternative Investments and Commodities. It will help you build a diversified portfolio that aligns with your personal risk tolerance and investment goals. Also, a reminder to make sure to only invest what you can comfortably lose and do your own research before investing! 

Thanks for tuning in! I hope this blog post has been informative. Remember, investing is a marathon, not a sprint. Take your time, do your research, and build a portfolio that works for you.