When it comes to investing, you will frequently see references to an asset class – be they stocks, commodities or mutual funds.
But what do they all mean?
Having a firm grasp of the basic principles of each asset class can aid investors in making more well-informed investment decisions and achieving their long-term investment goals.
Equities/Stocks
One of the most well-known asset classes is equities, more commonly referred to as stocks.
By owning stocks in a company, investors can participate in a company’s successes via increases in the company’s share price and will, in most cases, receive payments through dividends.
When purchasing stocks in a company, an investor will fall into one of two distinct categories: common and preferred shareholders.
Common shareholders will be entitled to voting rights at shareholder meetings, whereas preferred shareholders will yield their voting rights in favour of receiving preferential treatment when the time comes to pay out shareholder dividends.
However, stocks can just as easily go down in value as up. If a company enjoys success your stake can increase in value. But if it underperforms or outright fails, it can leave shareholders in a precarious position, making equities one of the riskier asset classes to consider for an investment portfolio.
Property & Commodities
Property and commodities fall into the more tangible side of asset classes, as they represent ‘real’ things that an investor can see or interact with, such as a building or a bar of gold.
Property can mean land or the buildings on top of it, as property investors will typically diversify their assets to include a range of property types, with anything from an office block, homes to fields and forests.
Commodities follow a similarly diverse pattern, with anything that can be readily exchanged for money falling into this asset class.
Investors in property and/or commodities will see their gains through appreciation as their assets can steadily increase in value over time, either due to the natural ebb and flow of supply and demand or, more significantly, when influenced by external impacts on the market.
Stockpiling oil when prices were low during the Covid-19 pandemic of 2020, for example, will have paid dividends when the price of oil spiked in 2022 following Russia’s invasion of Ukraine which saw prices spike.
However, if external market forces affect your property or commodity assets negatively, such as a downturn in the housing market or a sharp increase in the supply of a particular raw material you already possess, it will be challenging to liquidate that asset for a price which delivers profits or even breaks even.
Mutual Funds
Mutual funds involve having like-minded investors/shareholders pool their capital for a group investment in stocks, bonds or other securities.
This allows, for example, greener investors to own shares in a high-profile company that they would otherwise be unable to afford.
After investing in a mutual fund, the capital raised will be managed by a fund manager who ultimately decides how to invest the mutual fund’s money.
Many managers will actively manage their mutual funds, tracking and allocating how the capital is being used and investing in their own unique style, whereas others may follow a more rigid structure, typically mimicking already successful investment funds such as the S&P 500.
One of the inherent benefits of investing in mutual funds is that even a comparatively small investment provides your portfolio with tremendous diversification by exposing you to hundreds of different securities within the mutual fund. Because of the highly diverse nature of this asset class, the level of risk is typically lower than with stocks, commodities and property alone. Many will, however, lock you in for a minimum fixed term.
Cash
As an asset class, cash is considered a short-term investment and tends to suit investors who are looking for stability over windfall returns.
The most obvious investment is in an interest account which accrues funds over time – but obviously depends on interest rates delivering a reasonable rate of return.
The stability of cash investments comes from the low level of risk. However, care must be taken to monitor inflation to avoid increasing rates eroding the purchasing power of the cash you own.
Fixed deposit accounts, in part, offset this loss of purchasing power through inflation by offering fixed rates of interest – higher than offered by a normal bank account – to be accrued on deposits made as long as the funds are left in the account until the maturity date.
Money market funds operate in a similar fashion, as it provides investors with a safe and easily accessible fund. A common characteristic of money market funds is their low-risk, low-return nature, with investors seeing returns from purchasing short-term investments such as certificates of deposit (CD’s), treasury bills and short-term commercial debt.