Welcome to my plain English guide to asset classes.
It’s one of the first major posts on my site because asset classes are the building blocks for your investment strategy. It’s really important to know about all asset classes.
I am going to attempt to cover as many as possible in this article, so let’s jump straight in…
What are asset classes?
Asset classes are essentially a broad group of investments or securities that have similar financial characteristics. The easiest way to explain what asset classes are is to list the four that have traditionally been seen as the major asset classes:
– CASH
– SHARES / STOCKS / EQUITIES
– PROPERTY / REAL ESTATE
– BONDS OR FIXED INTEREST SECURITIES
I will go into more detail below and explain these big four asset classes. I will also list the many other asset and sub asset classes that have emerged over time, for example precious metals like gold and silver, wine, ETFs, collectables that can be traded (e.g. wine, stamps, art), classic cars, cryptocurrencies, commodities (e.g. oil, gas, iron ore, agricultural products)
Essentially an asset class can be defined as a broad type of investment.
Why should an investor care about asset classes?
Asset classes are key to the diversification of your portfolio and avoiding having all your eggs in one basket.
If your entire portfolio is all in shares then you are exposing yourself to a big hair cut if the stock market crashed. Similarly, if you keep all your money in a cash ISA then you are exposed to currency movements and inflation. Ideally you will have a diversified portfolio that will stand up to all economic climates.
You should now be aware that mixing different asset classes is knows as diversification. It helps you manage the amount of risk you take with your portfolio. Asset allocation is the proportion of your portfolio that you put into each asset class.
How can I manage risk with asset allocation?
Investments are likely to move up and down, so it’s important to be familiar with risk. Different asset classes will carry different risk. Cash savings are considered the least risky while shares are considered the most risky of the major asset classes. I will explore the topic of asset allocation in another article because it’s a huge subject in it’s own right.
What are the potential asset classes open to you?
Here is my guide to the asset classes and sub classes that can be easily invested in.
I will also explain how you can purchase these assets.
1. Cash
The asset class that every person probably has, assuming they have some savings. Cash is of course the most liquid of all assets. You can use it pretty much anywhere and exchange it for all other assets. It’s seemingly the perfect asset to have, but as an investment it carries it’s own risk.
The main risk to your cash or savings is inflation.
Inflation in the UK is currently around the long term average of 2%. If your cash is not making more than 2% then you are essentially losing money and your savings will not have the same purchasing power in the future.
The problem is that savings and bond/term accounts and cash ISAs have been offering very poor rates over the last few years. It’s currently very hard to get above 2% unless you are tying your money away for a long time.
How can I invest in cash?
You could keep your cash in a current account. That is technically investing, but only if inflation goes into negative territory. You really need to put your cash somewhere it can grow.
Savings account, fixed term bonds or cash ISAs
These are the tradition ways to invest in cash. You’ll usually receive interest on your deposit. This will typically be low but have been double digit like in the 1980s. It’s unlikely we will be returning to double digit interest rates anytime soon.
Other currencies
Another way to invest in cash is to buy foreign currencies. If the £ (or your own currency) is particularly strong then it might be worth buying a currency that is currently weaker. £1 GBP once bought $2 USD (it’s currently buying $1.30). Had someone bought USD at that time they would have made quite a bit of money (once converted back to GBP). This is basically what FOREX traders do on the money markets. It’s actually considered quite high risk, certainly compared to savings and fixed bonds accounts from Banks.
2. Shares / Stocks / Equities
A share is a unit of ownership in a company. Its value is calculated by dividing the value of the company by the number of shares available. Shares probably offer the most diverse way of investing and it’s never been easier or more accessible.
Shares are also one of the riskiest investments too, although some shares tend to be riskier than others! With risk come reward or potentially the loss of a lot of your investment.
You can choose to invest in individual companies or an ETF (exchange traded fund) that may contain a number of different companies. Theoretically ETFs might be seen as less risky as you are spreading that risk.
How can I invest in shares in the UK?
There are many online trading platforms open to UK citizens where you can transfer your cash and then buy your shares. You will usually be charged a small fee when you sell and buy shares.
This is a great introduction into UK share dealing.
3. Property / Real Estate
This asset class needs no introduction! Property investment can be seen as the goose which lays golden eggs – an easy way to make money. But the truth is it takes a lot of effort and some luck to make it work.
How can I invest in property?
You can of course buy a flat, house or any residential dwelling. You can also purchase commercial and industrial premises too.
When it comes to investing, it’s most important to work out what yield you’re going to get. This is the amount of money the property generates per year minus anything you spend on maintenance, rates and other costs, divided by the value of the property. You want to get a yield of 6% per year. You can take steps to increase your yield – like those renovations – but be aware they will cost money at the outset.
4. Bonds or fixed interest securities
Fixed interest securities are a way for companies or governments to raise money by borrowing money from investors. Securities issued by the UK Government are also called ‘gilts’ or ‘gilt-edged securities’, while securities issued by companies are known as corporate bonds.
In terms of risk, government bonds or gilts are seen to be the least risky, particularly compared to shares, but also less than corporate bonds. Corporate bonds are generally considered less risky than shares.
Most fixed interest securities provide a regular, stable income from their interest payments.
How do I invest in corporate bonds and GILTs?
Newly issued gilts can be bought from the UK government’s Debt Management Office.
Corporate bonds can be bought for you in the market by a stockbroker who will charge a fee. A financial adviser or investment manager will also go through a stockbroker. Many corporate bonds are bought and sold in very large minimum amounts. But some, called retail bonds, can be bought and sold in much smaller units designed to be suitable for private investors.
Another way to invest is to buy ETF tracker funds that will track the price of GILTs and corporate bonds. There’s usually a fee taken from your returns to pay the fund management company.
Other asset classes and sub-asset classes
There are more asset classes that can be a consideration for your investment portfolio.
Here is a brief description of some of them.
Collectible (or tangible) assets
These include actual objects such as fine art, wine, stamps, jewellery, antiques, classic cars etc. They can be a fun way to hedge against inflation but also carry their own risks too. It’s best to choose items that are no longer being made or in production.
Gold, silver and other precious metals
Gold also needs no introduction and has been used as a store of value for 100s of years! It could well be included as a collectible asset (above) but is slightly more liquid (easier to buy and sell) because it’s actively traded around the world.
You can also invest indirectly in precious metals e.g. buying shares or ETFs of gold mining companies.
Peer to Peer Lending
This is where you lend money to other people or companies in return for an interest payment (and your original investment). These have become very popular recently but carry their own risks. They are not backed up by the government, so you could lose you whole investment.
Bitcoin and other cryptocurrencies
Cryptocurrencies are basically unregulated digital money although most are not particularly easy to spend, and all carry a high level of risk. With this risk can come massive rewards too, as seen by the recent rise of Bitcoin. Bitcoin is probably the most well-known cryptocurrency but they come in many forms which include Ethereum, Ripple, Litecoin and Bitcoin Cash.
DISCLAIMER – The information on tonypage.co.uk does not constitute investment advice. Always do your own research.