Struggling to understand financial lingo and concepts? Here is our guide to asset classes.
Investing your money is probably one of the best things you can do. But knowing which asset class to go for and understanding how they actually work can be confusing. Making an investment is all about taking on risk in order to make a return. The rule of thumb is the more risk you’re willing to take on, the higher your return and vice versa.
There are four main assets classes: cash, property, bonds and equity. Here we look at the two asset classes on either side of the risk spectrum.
Low risk, low return: Cash (short-term investments)
Financial Advisor Onalenna Disipi from Liberty Life explains that low-risk investments are those made over a short-term and are subject to less fluctuations and risk. “Somebody who wants to secure their investments or capital and not be exposed to too much volatility in the market would be a low risk investor,” says Disipi. These investors take a conservative approach.
Low-risk investments include short-term debt instruments like Negotiable Certificate of Deposits (NCDs) and US Treasury Bills. A safe and easy way to access this asset class and earn a higher return than your normal bank account is through money market funds, which all the large fund houses have. However, a low interest rate environment will mean very low nominal returns.
Disipi stresses that cash investments should not be made for the long term because “inflation will eat away at your investment value or purchasing power”.
High risk, high return: Equities (long-term investment)
A high-risk investment is one that is subject to huge fluctuations in the market and should be made over the long term (for longer than ten years). Disipi says that a high-risk investor is one that takes an aggressive approach and is “willing to expose themselves to volatility knowing that they will yield returns in the future.”
High-risk investments would be shares (equities) in companies that are traded on exchanges like the Johannesburg Stock Exchange. The risk within the asset class varies. For example, a large multinational trading in developed countries will be less risky than a small mining exploration company operating in a politically unstable developing country.
Historically, equities have outperformed inflation. You can access shares through a broker, online platforms or through funds. Remember, the most important rule about investing in equities is diversification, so don’t put all your eggs in one basket.
Other alternative asset classes you might be interested in include hedge funds, art, stamps, antiques and anything else that has the ability to appreciate in value.