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Investing 101: What does “asset class” mean?

(Also read the following related article: "New book teaches the uninformed and intimidated about money and how to grow it")

There are four main asset classes:

Each of these can be either local or foreign.

Different asset classes have varying levels of risk and expected returns. It is important to accept the direct relationship between risk and return; the more risk an investor is willing to take, the higher her expected return will be.

Cash (very low risk, very low returns, very liquid)

A money market fund refers to a fund that invests in “cash” instruments.

It is the least risky and most liquid (i.e. you can “get” your money at a very short notice) asset class over the short term.

While the yield or “interest” on a money market fund is generally higher than that offered by a normal bank account it is still, in many cases, lower than the rate of inflation. This means that an investor who invests all their capital in the money market can expect a negative real (i.e. when taking inflation into account) return.

So, while the money market is an ideal place to keep funds safe over the short term, it is far from ideal for purposes of generating inflation beating returns over the long term.

Fund managers will often incorporate the money market to reduce the overall risk of a fund.

Bonds (low risk, low returns)

Bonds are instruments that governments and companies use to borrow money from investors.

Bonds are also interest bearing instruments.

Over the short term, bonds are less risky than equity and property, but slightly more risky than money market instruments.

Bonds are also frequently used by fund managers to reduce the overall risk of a fund.

For the purpose of long term inflation beating returns, bonds are also not ideal. It is much more suited as a method to preserve capital (i.e. it’s good for keeping the value of your investments safe while not really growing it that much).

In an upcoming article we will look at property and equity as the two other main asset class types and the ones you want to invest in if you want to grow your wealth and comfortably beat inflation.

Claude Hannah is a financial planner for Venn-Sure Consulting. He completed a degree in Financial Risk Management from the University of Stellenbosch in 2006 as well as a post graduate diploma in Financial Planning. Claude helps to organise and simplify the often complicated and busy financial lives of his clients. He takes great pride in providing the highest level of service to help his clients build and protect their wealth. For more information, email him (claude.hannah@liblink.co.za) to arrange for a free consultation.

(Also read the following related article: "New book teaches the uninformed and intimidated about money and how to grow it")


This article first appeared on 702 : Investing 101: What does “asset class” mean?


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