All investments are not equal and where you put your money will have an impact on the protection of your original capital and your returns over time. There are four primary types of asset class, each of which comes with different risk/return potential. What are they and how do they fit into an asset allocation strategy?
What are Asset Classes?
This term is used to describe particular types of investment which share common features, benefits and elements of risk. Each class can include many different options. For example:
- Cash – savings accounts and money market investments.
- Bonds – government and corporate loans.
- Property – real estate or property products such as funds and trusts.
- Shares – investments in companies.
Each could have a different effect on the way your money performs. Generally, this is measured by a mix of risk and return.
Asset Class Risks and Returns
You can measure each class based on certain factors. Some investments, for example, are safer homes for your capital than others; some impose higher risks that you might lose some of your money. The lowest returns tend to come from the safest investment and the potential to make most money comes from higher-risk options.
Cash is the safest option but it won’t give you the most significant capital growth. Bonds may up the ante with a slightly higher degree of risk and better returns. Property and related sector products are often viewed as a solid long-term strategy. Shares are the most volatile of these four classes but, if they perform well, could give you the best returns over time. For many investors, building a portfolio involves spreading investment across one or more classes.
Investments and Asset Allocation
The term asset allocation describes the classes in which you have invested your money and the way that it is divided between them. So, for example, you could have 20% of your assets in short-term cash products, 30% in bonds and 50% in shares. This spread can be changed over time if your needs or circumstances change.
Many of us use this investment model without even realising it. You could simply be using a savings account to build up some money or be in the process of buying your home. This may be simple and relatively risk-free. Things can, however, get more complicated in certain scenarios.
In some cases, you may be looking to build specific funds (e.g. for retirement) and may change the way you invest as you get older. So, if you start to save at a young age, then you can afford to take more of a gamble and use a higher weighting towards shares. Over time, you would hope that the peaks and troughs of this sector would even out in your favour.
But, as you approach retirement age, your allocation of asset classes might change. As you get older, therefore, your strategy may switch from a high risk tolerance to one of safety. This could involve moving your money out of volatile investments and into safer ones to protect the funds you have created.
If you’re interested in learning more about how each class might impact on your financial planning and prospects, then it may be worth taking a look at an online asset allocation calculator. This can give you a base-line snapshot of how each type of investment could perform on both a stand-alone and a combined basis and could help you better achieve your savings goals.