Investing

Simple guide to the different types of asset classes

18 November 2020 | Posted by Claro Money
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The different types of asset classes, including stocks, shares, bonds and commodities, is what makes up investment products.

Why should you care?

Each type of asset class has its own characteristics which you can use to construct a portfolio that has the right mix of risk, reward and liquidity for your financial goals.

What will you learn?

In this pack, you’ll get a summary of the main types of asset class, how they work, and what to consider if you want to get in on the action.


What are asset classes?

Usually, assets in the same asset class are subject to the same laws and regulations too.

The primary asset classes are:

Stocks: buying stock gives you part ownership of a company, also known as equity.
Bonds: by investing in a bond you’re lending money to an organisation, in return for interest payments, also known as fixed-income securities.
Commodities: Investing in commodities means investing in physical goods, like gold.
Cash or cash equivalent: cash and other assets that are as good as cash.
Property: owning property.

How do different types of assets work?

Stocks and shares

Stocks and shares give you the right to dividends or a share of the profits of a company.

Companies issue shares to raise capital. The most liquid stocks are from publicly listed companies, like those in the FTSE 100 (in the UK).

The price of stocks and shares goes up and down, depending on the market’s behaviour or how many people are looking to buy and sell. When more people are looking to buy, usually the price goes up. However, other factors also contribute to the price change of stocks and shares.

They can reward investors in two ways:

  1. By increasing in value as the company attracts more buyers
  2. Through a regular income stream from the company’s profit.

The potential return on your investment in individual stocks and shares will depend on the price for you buy and sell them for. The higher the selling price, compared to the buying price, the better.

Stocks and shares generally grow with the economy, and well-picked stocks stay ahead of inflation.

Bonds

In simple terms, a bond is an ‘I owe you’ (IOU) from a government or corporation. When you buy one, you are loaning money to that institution.

Companies sell bonds to fund activities, such as innovation, growth and new products. Governments issue bonds to fund expenses, infrastructure projects, military expenses, or to pay back the interest on their existing loans. UK government bonds are known as ‘Gilts’. US government bonds are known as ‘Treasuries’.

Bonds are sometimes referred to as fixed-income assets because they pay out a fixed income each year.

A bond has a maturity date and a ‘coupon’. For example, you might buy a 10-year bond with a 5% coupon for £100. That means you’ve given the institution £100 for ten years. In exchange, the company will pay you 5% interest (£5) each year until maturity, when it will give you back your original £100 too.

You should also know that bonds can go up and down in value with their market price when publicly traded.

Bonds are a great way to diversify your investment portfolio because they are usually negatively correlated with stocks. They give you a fixed income and return your initial investment at the end of the bond’s term, which can provide the stability you can’t get from stocks. Remember that bonds (especially corporate bonds) are less liquid than stocks, which means not as easy to sell back to the market.

Although bonds are less risky than stocks they still hold a certain level of risk. You should look at a bond ratings when deciding to buy or not. Anytime you invest your capital is at risk.

Cash and cash equivalents

Given that cash is the very thing you are investing in the first place, it might seem weird to consider it as its own asset class. But it is!

This asset class also includes ‘cash equivalents’ which you can easily convert to cash. Common examples of cash equivalents include commercial paper, treasury bills, short-term government bonds, marketable securities, and money market holdings (which we won’t go into here).

Collectively cash and cash equivalents are abbreviated to ‘CCE’.

Property

Investing in property, whether residential or commercial, can generate wealth in rental income or if the value goes up. You can then either sell the property or take out equity to purchase more properties or make more investments.

The value of property investments tends to rise and fall more slowly than stock and bond prices. This makes them a more steady investment option. Property investing comes with risks, including a fall in the property’s value, expenses, and potential liabilities.

Commodities

Commodities are physical goods used in commerce. They are typically raw materials, basic resources, agricultural, or mining products, like gold, iron ore, sugar, or grains. Commodities can also be mass-produced unspecialised products such as chemicals and computer memory.

The quality of a commodity may differ slightly, but it is essentially uniform across producers. You may hear that commodities have full or partial ‘fungibility’; that means the market treats the goods the same no matter who produced them. Gold is gold wherever you get it from.

Demand for commodities tends to be high during periods of high inflation, which helps protect the real value of your investment.


What to consider when investing in different types of asset classes

For people who aren’t professional investors, stocks are one of the most popular forms of investment because they are easier to understand and to buy. But you need to have a lot of knowledge of financial markets and a company’s financial health to pick which individual shares to invest in.

Value can fluctuate


You should also know that stocks go up and down in value with their market price, unlike other asset classes such as bonds and cash. Bonds go up and down in value as well.

Bonds are a great way to diversify your investment portfolio because they usually have a negative correlation with stocks. They give you a fixed income and return your initial investment at the end of the bond’s term, which can provide the stability you can’t get from shares. Bonds only guarantee a return of your initial investment if you bought them new. Remember that bonds (especially corporate bonds) are also less liquid than stocks, which means it’s not as easy to convert them back to cash.

Buying property yourself is not the only way to invest in this asset class. You can purchase shares or bonds in property companies who either build, buy, sell or rent properties. Or you can invest in funds, including exchange-traded funds (ETFs,) which have property in their portfolios.

Make sure you have an emergency fund

Keeping some of your money in cash provides a safe haven for funds when markets are rocky or looking overvalued.

There are two types of commodity buyers: the ones who take delivery of the actual commodity, and the ones who speculate on price fluctuations. With commodities, regular retail investors won’t handle the goods physically. As with property, you can invest in companies or funds that specialise in commodities, rather than buying the commodity itself.

Both property and commodities often protect your future purchasing power as their values typically run in parallel to inflation. That means your investment typically will grow as the cost of goods and services grows. It’s good to have both in a broader portfolio as a diversifier and a hedge against inflation.

Property investments can take some time to sell compared to stocks or bonds, so they are less liquid.

Ethical considerations

Many people want to know how ‘ethical’ an investment is before they put their money into it.

If you fall into this category, you’ll want to look out for the environmental, social, and governance (ESG) criteria of different investments. There are a few ways of measuring and reporting on ESG, but they all give you a perspective on how ethical and sustainable an investment is. See our ‘Ethical Investing Unpacked’ pack to find out more.

With stocks and bonds, you have a lot of freedom to choose the ones that most align with your values. The downside is that the information about a company’s environmental, social and governance sustainability may not be available or easy to find.

Ethical property investment opportunities are hard to find. But there are companies and funds that are popping up that deliver affordable housing or workspaces for people who need them.

Ethical investing in commodities can pose a problem. Mining and farming practices might go against best practice social, environmental and governance standards – especially in countries with poor human rights records. But the increasing consumer demand for Fair Trade and organic goods has been good for ethical investments. You need to watch out for unintended consequences or trade-offs associated with some seemingly ethical commodities. For example, biofuels, while being better for the environment compared to crude oil, have to compete for land use that could otherwise be used for food production, and are often sold on to larger petrochemical companies.


Where to get different types of assets from

Where you get a particular asset will depend on the class it belongs to. For example, stocks are sold on stock exchanges, while commodities on commodity exchanges.

The simplest way to invest a variety of assets is via funds that already hold the different asset classes you want as part of your portfolio.

Brokerages can help you buy these assets, and bonds too.


Key takeaways on the different types of asset classes

That’s a wrap! Here are the key takeaways from this pack.

Asset classes are different types of investments that work in a similar way.
The five main types of asset class are stocks and shares, bonds, cash and cash equivalents, property and commodities. They all have different benefits and risks.
The simplest way to invest in a variety of assets is via funds that already hold the different asset classes you want to have as part of your portfolio.
It’s good to have a mix of different asset classes in a broad and diverse portfolio because it reduces the risk of losing your money.
Looking at environmental, social, and governance or ESG ratings can help you choose an investment that fits with your ethical concerns.

Remember that investment values naturally fluctuate. When investing your capital is at risk.


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