Investing can feel overwhelming even for experienced investors. The jargon and assets can be very confusing. What are equities, fixed-income investments, and commodities, for instance? What do they “do”, and how can they be integrated into an investment strategy?
In this guide, our Burnley financial advisers explain the most common asset classes for investors and what role they could plan in a portfolio. We hope this is useful. Please get in touch if you have questions or want to book a free, no-commitment consultation with us.
Cash
Let’s start with the most familiar asset class. Cash can be physical money in your hands, like coins and notes. By saving it, you can generate interest.
It is widely considered “safe” since its value does not fluctuate on the stock market. Savings in UK banks can also be protected up to £85,000 under the Financial Services Compensation Scheme (FSCS).
When investing, cash can also refer to other “liquid” (i.e. easy to sell) investments like money market funds and short-term treasury bills. These are low-risk, short-term debt instruments that can offer higher returns than cash.
Cash investments can be a safe place to store wealth for short-term goals, such as saving for a first mortgage deposit. However, they are less effective for building wealth over many years (e.g. growing a retirement pot) due to inflation eroding their real value.
Equities
Interested in investing in companies? Equities open up this possibility by letting you buy shares on a stock exchange, such as the New York Stock Exchange (NYSE, the biggest stock market in the US).
You can buy shares in companies directly on an investment platform. Or, you can buy them “indirectly” by buying shares in funds. These collect money from many investors and buy company shares on their behalf.
If your shares rise in value, you can crystallise a “return” by selling for more than the original purchase price (i.e. a capital gain). Another option is to buy shares in companies that pay out a regular dividend (a share of their profits).
Equities can be exciting because they allow investors to gain ownership of companies in different regions, markets, and sectors. They also offer the potential for high investment returns compared to other asset classes.
However, equities can bring a higher investment risk. If you buy shares in a company that fails, you may lose some (or all) of your initial capital. A financial adviser can help you mitigate this by diversifying your investments – i.e. spreading your money across many different companies.
Fixed-income securities
The most prominent type of fixed-income security is the “bond”. It can help to see a bond a bit like a loan. Except you (the investor) are the one lending the money to an “issuer” – a company or government that puts the bond out into the market.
By purchasing a bond, you agree to lend your money on condition that it is repaid at an agreed maturity date (e.g. in 2 years). You will also receive regular interest payments (“coupons”) along the way.
For instance, the UK government issues bonds (called “gilts”) to help cover its public spending commitments (which are not fully funded by taxation). An investor can buy gilts for multiple durations – e.g., maturing in five, fifteen, or even fifty years.
Similar to equities, bonds can be bought directly or via a fund. The former can sometimes offer benefits (e.g. tax-free capital gains for gilts). The latter can offer more diversification as your bonds are spread out across multiple issuers.
Different issuers carry varying risk levels regarding repayment. Remember, if the issuer cannot repay the money due to a default, you may not get your original investment back.
Here, rating agencies like Moody’s will award bond ratings to help investors discern the risk levels of different issuers. For instance, the UK government has an “AA” rating partly due to its track record (it has never defaulted).
The “safer” a bond is perceived, the lower the interest rate it tends to offer. However, “riskier” bonds (sometimes called “junk bonds”) will often compensate by offering a higher interest rate.
Property
An investor can, of course, buy an additional property directly for investment purposes, such as a buy to let (BTL). The intention may be to sell it later at a profit, possibly generating an income along the way using rental payments.
Alternatively, investors can buy shares in property funds to pool their resources with other investors. A prominent type of property fund is the REIT (real estate investment trust), which receives rents from many properties and distributes the profits (dividends) to investors.
A REIT can offer investors many advantages over direct property investment, such as more liquidity. REITs are generally easy to buy and sell on stock exchanges. Selling a buy to let, by contrast, can take a lot of time and expense. Property funds can also provide a high degree of built-in diversification for investors.
However, publicly traded REITs can be as volatile as stocks. Property investments can be particularly sensitive to changes in interest rates. Long-term growth potential may also be held back by the requirement to distribute 90% of profits to investors (rather than reinvesting them).
Next steps
There are many other asset classes we could talk about. However, the above – cash, equities, fixed-income and property – should be enough to get you started with a financial adviser!
If you’d like to make sure you’re taking the right steps to build your portfolio, please get in touch.
