Understanding Asset Classes

Whether you're a sophisticated investor or a novice dipping your toe in the water for the first time, it's crucial to understand how different asset classes can help you achieve your investment and lifestyle goals.

An asset class is a specific category of assets or investments which have similar characteristics including risk and return expectations.

The four main asset classes are shares (securities in a company), fixed interest (bonds and securities), cash (term deposits and property).

Asset classes also fall into two main categories – growth and defensive. They will perform differently depending on the underlying economic conditions at any given time. And some will be better suited to your needs than others.

For example, you might want your investments to provide you with a regular source of income, or you might be looking to generate long-term capital growth. You might have a low tolerance for risk, or you might want ready access to your money.

When you understand the pros and cons of each asset class, you will be able to make more informed investment decisions that suit your wealth management and lifestyle goals.

Growth assets

Growth assets focus on generating capital growth and income. They are suited to investors looking to grow their investment over the long term – usually seven to ten years. They include shares, property and alternative investments.

Growth assets tend to have higher levels of risk, but they also potentially deliver higher returns than defensive assets over longer investment time frames.

Shares: Also known as equities or stocks, shares are securities that give investors part ownership in a publicly listed company.

If the company performs well, you can benefit from share price growth (capital growth) and receive income paid as dividends. But if the company performs poorly, your shares could fall in value and there may be no dividend payments.

Because share prices fluctuate daily and react to short-term market volatility, it's worth holding shares for at least five to seven years to maximise returns.

You can choose to invest in Australian shares, international shares or a mix of both.

When you understand the pros and cons of each asset class, you will be able to make more informed investment decisions that suit your goals.

Property: Property can include investments in direct property, global property, listed real estate investment trusts (REITs) and other property securities.

Property is considered a growth asset because the value of residential, commercial and industrial property can increase substantially over the medium-to-long term, generating higher returns than cash or fixed interest.

But just like shares, property can also fall in value with the risk of losses. REIT unit prices, for example, can fluctuate based on underlying property fundamentals or share market volatility.

Defensive assets

If you’re looking for more stability, defensive assets are considered lower risk and will generally generate income more consistently. They include investments like cash and fixed interest.

Because defensive assets tend to have lower risk levels, they generate lower returns over the long term compared to growth assets.

Cash: Cash investments include short-term bank deposits, 90-day bank bills and high yield savings accounts.

Cash is a defensive asset because it provides a stable, low-risk income in the form of regular interest payments. The beauty of cash is that it is highly liquid and has less capital risk than growth assets, which is important when it comes to protecting wealth.

But cash also has one of the lowest potential returns of all asset classes, particularly in a low interest rate environment.

Fixed Income: Fixed interest investments include government and corporate bonds, debentures and mortgages and might suit you if you’re looking to invest over a one to three-year timeframe.

When governments or companies issue a bond they are effectively borrowing money from investors. In return they pay investors a regular rate of interest (an income stream) over the life of the bond with the borrowed amount repaid when the bond matures.

Bonds are considered a defensive investment because they generally offer lower potential returns and potentially lower levels of risk than shares or property. But the income stream from bonds can be higher than earnings from a cash investment.

It's important to understand that bond prices move in an inverse relationship to interest rates. So when interest rates are declining, bond prices will rise, which often makes them more appealing to investors.

But when interest rates start rising, the market value of bonds falls. That means there's a risk you could lose some or all of your capital, particularly if the coupon rate of the bond (the fixed periodic interest paid to you) is lower than the official cash rate.

Whatever your wealth management goals are, the key is not to put all your eggs in one basket. Different types of investments and different asset classes will do well at certain times, while others won’t. If your portfolio has some variety, you can rest assured that at least some of your investments are likely to be performing well.